Is Tesla Overvalued? Yes, but the question is by how much!

Read Time: 4 mins

In this bull market, everything looks like a golden globe that can save you from all forms of crisis. Although this pandemic started with an extreme bear market where indexes plunged by 40% or more, we are currently in a strong bull market. With no guarantee of this being a bubble driven by tech companies and companies of the future, the market stays volatile where the VIX went to 82.69 as of 16th March 2020. 

2020 has been a year of uncertainty filled with crisis, a pandemic, oil wars... Adding on to these uncertainties is the current stock market and the highly valued companies of the future. There is no right way to value a company since valuing a company in long term incurs a lot of variability in terms of the people who are running the company and the environment that supports the company. Keeping these things in mind I have used intrinsic valuation for Tesla using a Discounted Cash Flow (DCF) methodology. Based on optimistic analyses of the company, as I also believe that Elon Musk is bringing life-changing technologies to us, Tesla is overvalued.

The question of how much still stays. Firstly, let me quickly talk you through a DCF model. A DCF model uses the future cash flows of a company and discounts it to their present values. Here I have projected the cashflow of Tesla till 2025 and then added a Terminal Value (Assuming the future growth rate, consider TV as the value of perpetuity). Putting the detailed assumptions out of scope for this blog, I'll put down the key factors that matter and makes the most difference to the valuation:

• Revenue Growth (50-30%)
• Aligning with Elon Musk's statement where the expected growth rate is 50%, for the valuation, I have used a 50% growth rate for 2021 sliding slowly to 30% for 2025. As GM, Nio, Nikola, Apple, and other big players are coming in the EV market this growth seems optimistic but achievable. 
• Tax Rate (25%)
• Based on the last 12 months where Tesla paid 25.3% in taxes, I have used a round off figure for there effective tax rate as 25%
• Discount Rate (8%)
• Tesla's Cost of Equity currently stands at 12.61%
• Cost of Debt: 0.90%
• Based on the D/E ratio it's WACC stands at 12.41%
• However, being highly optimistic about their future, I have considered a highly optimistic discount rate of 8%, which align more with the like of 2018 and 2019 WACC for Tesla.
• Terminal Growth Rate (4%)
• Considering anything over 2%(Average Inflation rate for the US) as highly optimistic and knowing that Tesla is a young company with huge future potential, I had to settle with the Terminal growth rate as 4%

Based on the aforementioned assumptions, I came at a fair share price for Tesla being $478.02

This is not a magic number which leads to the exact value of Tesla's share but is somewhat nearing the range based on the future revenues of the company and taking into account the businesses that Tesla plans to move into in the future.

Taking the excerpt from the Bloomberg article published in Dec 2020, Tesla is a car company in the way Apple is a phone company. As the car becomes connected to the internet, that opens up a lot of other addressable markets that historically were never available to car companies, and even today -- from the way most car companies design their cars -- those markets are still not available to them. Tesla is moving people away from valuing and analyzing the company by just using the number of units sold and the price of the car and bringing into account the installed user base and the software and content services offered to those users. In the process, it takes you away from comparing Tesla to car companies and should rather be compared to software-as-a-service companies.[1] 

From a valuation of Morgan Stanley at $540, $254 is attributed to the core car manufacturing business, $154 is attributed to the network-services business, $58 to the potential of supplying batteries and powertrain to third parties, $38 to the mobility and ride-sharing business opportunity, and $25 to the insurance and energy business. Taking all these into account and believing in the vision and capabilities of Tesla, the company stills stands as being overvalued on the stock market.

Justifying the future revenues and profits for Tesla, I am adding a snippet from Bloomberg Terminal which also estimates the future revenue with mine being more optimistic than theirs. Holding true on the fact that no matter how optimistic you become, unless everyone in the world owns a tesla and buy more than 1 car for themselves, this value of $872.79 as of 2nd Feb 2021 becomes very hard to justify.

Attaching below an overview of the DCF valuation and the snippet from Bloomberg Terminal.

Hope you had a great read through this. On a closing note, I want to remind you that this valuation consists of a lot of assumption. Although most of them are backed with facts, this should not be taken as a piece of investment advice. I, alongside many others, can be wrong on this valuation and would love to hear your biases either in favour or against this valuation in the comments section below.