Tesla's results and valuation. What is a fair price to pay?

This is going to be a blog for me to organize some scattered thoughts and to deposit them in my Pensieve.

I am mostly an investor for income with an eye on value.

So, I did not pay much attention to high tech stocks which were mostly classified as high growth stocks at the same time.

The eye watering PE ratios were just too off putting.

Of course, in the years when interest rates were almost zero, investors who were looking for higher returns were more forgiving.

So, growth stocks took off and eye watering PE ratios became eye popping.

Now that cash is no longer trash, investors are more demanding. 

Investors want to see profits and not just promises of future profits.

This has led to the decline in the stock prices of high tech stocks.

However, if we are still interested in investing in high tech businesses because many of them are arguably going to be even more important in the future, then, we want to look at the numbers of individual businesses.

We should not let the thinking or feeling of Mr. Market to guide our decisions.

Last night, I produced a YouTube video on Tesla and said that it was a strange animal.

Today, I woke up to see that Tesla's stock price has declined from US$181 to US$163 which is a significant 10% drop in just one day.

If you don't follow me on YouTube, you might want to watch the video here.

Anyway, in the video, I said that, from the latest quarterly report, it looked as if Tesla was no longer a growth stock.

Tesla isn't a value stock either. 

Tesla's stock price has plenty of room to fall before it becomes a value stock.

Tesla doesn't pay a dividend and, so, investors are not paid to wait for things to improve.

In the video, one thing I did not mention was what price I thought Tesla's stock should be trading at.

Tesla's PE ratio was around 50x when I looked last night. 

It should be around 45x today after its stock price declined.

This is still a very high PE ratio and suggests that Mr. Market is still pricing Tesla like a growth stock.

However, for a more accurate picture, we should look at the PE to growth (PEG) ratio since Tesla is supposed to be a growth stock.

In Tesla's latest quarterly results, they reported a 24% growth in revenue but a 24% decline in earnings.

A PEG ratio of 1.0 suggests that a stock is fairly valued and a ratio of below 1.0 suggests that a stock is undervalued.

So, with a PE ratio of 45x, to make a strong case to value Tesla like a growth stock today, Tesla should be growing its earnings yearly by 45%.

Of course, this is if we want to see a PEG ratio of 1.0.

If we were to think that a PEG ratio of 1.5 is reasonable which means putting Tesla on par with some Japanese car manufacturers, then, a 30% growth in its earnings would be sufficient with a PE ratio of 45x.

Aggressive price cutting to defend market share is hurting earnings and it looks like there will be more price cuts to come, according to Elon Musk.

It would take a very optimistic investor to think that Tesla would be able to grow earnings this year by 45% or even 30%.

Call me pessimistic but it would be quite amazing if Tesla should even be able to report zero earnings growth this year which is less bad than the negative earnings growth it saw in the first three months of the year.

As Tesla does not pay any dividends, Tesla's investors should have deep pockets too as they are not being paid to wait.

Optimism does not bring home the bacon.

If Tesla's earnings continue to decline which looks very likely at this point in time, then, its stock price should have more room to fall.

Tesla's investors should not be using borrowed money to buy more stocks of Tesla, to be prudent.

Margin should be avoided like the plague or margin calls could come knocking on the door.

Oh, I did not say what price I think Tesla's stock should be trading at?

Tesla has a cult following and cultists are fanatical by nature.

They probably don't care about the fundamentals.

So, although I think Tesla's stock should be trading at a much lower price than where it is at today, really, your guess is as good as mine.

All I will say is that if we are rational investors, we want to invest when valuation is more reasonable.

If Tesla is unable to deliver any earnings growth this year, then, its PE ratio has to be a lot lower in order to make it a more attractive investment.

The S&P 500 has a PE ratio of about 23x which isn't cheap either but it could be where Tesla's common stock has to be if it does not deliver any respectable earnings growth.

This would see the price of its common stock at 50% of where it is at today or about US$80.00 per share, all else being equal.

Are rose tinted glasses still in fashion?

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