Electric Vehicles and Clean Energy Corporation Tesla (TSLA 4.88%) It was one of the biggest winners on Wall Street over the past two years. Trading under $90 a share in early 2020, the stock climbed to $1,243 before sliding more than 40% in this bear market.
Such a significant pullback seems like an obvious “buy on dip” opportunity, but investors should consider the following before doing so.
Highlight Free Cash Flow
Look at any earnings report, revenue and earnings per share (EPS) usually dominate the headlines. But don’t underestimate the importance of free cash flow; It is the lifeblood of business. It drives growth, dividends, and buybacks that investors love. Meanwhile, bottom line profits can be deceptive because there may be non-cash items that distort the numbers.
Many investors see Tesla as not just a car company; Some consider it a technology company for its work with artificial intelligence and autonomous driving. It is also branching out into other sectors such as solar energy, energy storage and insurance.
No matter what you think of Tesla’s rating, investors can look at the business through a simple lens – how good is the business at generating cold, hard cash? You can see below that Tesla is basically as good as stronghold in converting revenue into free cash flow. Both companies get about $0.07 in free cash flow from every dollar of sales, and it’s been the same for three years and ongoing.
What premium is Tesla worth?
Investors can take a step forward and use the free cash flow to value the stock by looking at how much they are paying for that cash flow. The chart below shows the difference in valuation between Tesla and Ford, using the price-free cash flow ratio, which is similar to the price-to-earnings ratio but substitutes free cash flow for net earnings earnings. Although Tesla has fallen significantly in value, it is still about nine times more expensive (a 108-to-13 ratio for Ford).
Keep in mind a few important things: First, Tesla is a faster growing company than Ford. Tesla’s revenue has grown an average of 50% annually over the past five years, while Ford’s revenue growth has been negative 2% over the same time. In addition, Tesla is the number one driver and market leader in the electric vehicle category, which appears to be the long-term future of the industry.
I think it’s an easy argument that Tesla stock should be more expensive than Ford stock. However, it is unclear what this premium should be. Perhaps Tesla’s growth will eventually help the business generate cash flow more efficiently than Ford. Perhaps self-driving will become very important for Tesla, and it will add a lot of very profitable revenue to the company. While these things may be Happening, the company right now is just as efficient at making cash as Ford, no matter how you call it Tesla.
Tesla has enjoyed the first-motor advantage so far in its history, but the industry’s shift to electric could negate that over time. Competitors like Ford are well capitalized and are investing heavily to catch up in areas such as battery technology and autonomous driving capabilities. Investors need to be careful when paying for shares because they are “priced at future success” because that future is not necessarily guaranteed.
No one knows what the market will eventually get to value Tesla in the long-term. The stock could continue to fall a bit more if the market decides that Tesla should be valued like a traditional automaker like Ford. It is also possible that stocks will bounce back and regain new highs.
Investors should treat stocks with caution because you don’t know where the stock price will go. The dollar-cost averaging strategy can be useful, because you will slowly buy portions of the stock over time. If the stock goes up, that’s great – you’ve been adding on the way up. If Tesla lags further for a while, you will lower your average total cost as you go along. It is a win for investors.