Michael Farr says Tesla is simply too dangerous a guess for many buyers
Tesla's stocks are stupidly expensive. It can go higher and shareholders can be rewarded, or it can languish or fall.
There is no law that forbids getting stupidly expensive to get ridiculously expensive. In addition, speculative firms that actually experience explosive sales and earnings growth over several years may make unusual valuations appear justified for a period of time.
The problem arises when fantastic expectations disappoint and concerned shareholders look down to discover the thinnest of air beneath them.
The electric carmaker's stocks were added to the S&P 500 index last week and have struggled. But they're still up a staggering 690% this year and are now valued at nearly $ 617 billion.
The current valuation makes Tesla the sixth largest company in the S&P 500, and stocks in that company are expensive by any metric.
The price-to-earnings ratio for the entire S&P 500 is currently roughly 22.3 times the consensus earnings estimate for 2021. Tesla stock trades more than 168 times.
It's true that TSLA's earnings are expected to grow rapidly over the next few years, but the stocks are still valued at 77 times the 2024 consensus. If that sounds expensive, take a look at the value for money. Average value for money for the S&P 500 is 2.7x, while Tesla is over 13x!
What could go wrong
Some hot concept momentum stocks actually make fabulous long-term investments.
Many others don't, however, and the high-profile success stories from Apple, Amazon, and Microsoft can lead investors to streamline their herd decisions, ignore reviews, and exercise caution.
Stock prices have risen, but is this a fabulous investment with a market valuation of $ 616 billion?
The company is now worth more than twice the combined market valuations of Ford, GM and Toyota! Could it be worth three times one day? Could be.
One thing is sure to happen; Whichever way prices go – up or down – the Wall Street Wags choirs will sing the anthem, "Of course I knew." History is annoyingly obvious as soon as it becomes history.
Think Before You Buy
Are you considering buying Tesla stock? Two points: buying stocks at high valuations will decrease your expected future returns.
Second point: All high growth companies start trading in anticipation of huge future growth.
If this growth happens successfully, as it does for companies like Amazon, Facebook, etc., then everything is fine. But for Amazon and Facebook, there are a number of companies just struggling to survive their first economic downturn.
The point is, to build a business so successfully and Amazon, Microsoft and Tesla, fabulous ideas and flawless execution must be combined with luck and excellent timing.
The dot-com bonanza of the late 1990s was full of spectacular, sparkling companies that had never been heard of before. But they didn't make it to Tesla status.
Why Tesla is nothing special
My friend Jim Cramer recently commented on CNBC that Tesla deserves a halo that other companies just don't deserve.
Jim said, "Tesla is the stock that broke our view of stocks. It's a completely unconventional way of looking at stocks, and younger people look at a company that can make a battery and they dream dreams. They fit not to." They see things that we don't see. "But dreams don't last long without spreadsheets.
As my buddy, Doug Kass of Seabreeze Partners, says, "Tesla has a shallow moat. Adjusted for carbon sales, Tesla has never been profitable in its 17 years of existence (although there was no competition and no advertising was required.)"
The trailblazer for concept alchemy is Amazon. Amazon was the emerging online bookseller in the 1990s to convince Wall Street that revenue didn't matter.
As long as the concept continued to make sense and sales growth was strong, Bezos was able to build a huge retailer that wasn't weighed down by pesky things like profits or cash flow. It was a snow job that P.T. Barnum, and it worked. Amazon stocks rose despite positive earnings being 15 years in the future, and only because of an entirely different line of business (cloud storage).
But for every Amazon there are hundreds of current favorites like JDS Uniphase and Pets.com. In the early moments of the concept-driven rapture and the extrapolation of high growth rates over many years into the future, all things are possible.
Dreams are the reason people play the lottery and lottery results are the reason states operate them and generate millions in revenue.
A tough game
Tesla has already been a great success for investors and could one day turn out to be a great long-term stock. But when stocks get so expensive, there is far less room for error.
Tesla is more reliant on momentum investing and the "bigger fool" theory at these levels than anything else right now. It's far too speculative for investors like us.
If someone knowingly wants to roll the dice, Tesla could work.
My longstanding advice to gamers has been to go to Las Vegas! At least if you lose in Vegas, you get a free cocktail.
For most people, money is hard to make and harder to save. Disciplined, dispassionate investing creates wealth over time. Farr's advice is to leave the gambling to the players and focus on becoming a better investor. Happy Holidays!