Should you invest in Tesla?

Tesla. Is the stock worth buying right now? I was supposed to be joined by Chandan, the founder of secdiver.com. Unfortunately, an urgent issue came up, and he couldn't join us. I'm the co-founder and CEO of Xillion. We serve as a financial co-pilot for Gen-Y and Gen-Z, helping you multiply your money.

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Now, let's discuss Tesla. Full disclosure: I've been a Tesla investor since 2013. I bought more in 2018 and while I've diversified since, Tesla remains a huge part of my portfolio. My initial investment wasn't based on numbers; I was drawn to Tesla's vision. But now, I've crunched the numbers.

As of today, Tesla has a market cap of 650 billion dollars. It's a highly volatile stock, which impacts its cost of capital. A higher cost of capital usually results in lower valuations for volatile stocks. Currently, for every dollar Tesla makes in revenue, its market value is $7. Its price-to-earnings ratio is very high, at $66 per dollar of profit. The S&P average is around 15 to 20, so Tesla's number stands out. I won't delve into the details, but it has an 18% cost of capital linked to its volatility score of 2.

I considered a scenario where Tesla remains volatile, and its growth slows down. In this pessimistic case, its market value could drop below 200 billion dollars. This would put it in the same league as traditional automakers like GM, Ford, and Toyota, whose market caps closely match their revenues. Next, let's consider an optimistic scenario. Over time, companies often stabilize. In such a scenario, Tesla's prospects could look very different. But that's a topic for another session.

In my opinion, based on my calculations, Tesla's market value varies depending on its innovation level. Its current market cap is $650 billion. If Tesla stops innovating, it could drop by another 60-70%, landing around $200 billion. But if Tesla remains innovative, its market cap could easily triple in a less optimistic scenario. In a more optimistic scenario with long-term growth rates of around 7-8%, it could skyrocket to $4-5 trillion. I haven't even factored in elements like robo-taxis; this is purely based on market and company growth.

To break it down, I'm assuming a 40% free cash flow growth until 2030, followed by a 6-7% long-term growth rate. As Tesla becomes more stable over time, the cost of capital should decrease. Tesla's strong software, not just hardware, should also help maintain high operating margins.

In summary, the pessimistic market cap is around $200 billion, the slightly optimistic cap is around $2 trillion, and the highly optimistic figure sits between $4-5 trillion. The robo-taxi ideas from Cathy Wood and ARK investments are interesting, but let's consider them 'pie in the sky' for now. Feel free to ask questions at any point.

Now, full disclosure: Tesla stock is a significant part of my portfolio. I invested in 2013, again in 2018, and sold some shares in 2020, 2022, and a bit in 2023. Tesla has shown impressive revenue growth over the years. Although the growth rate has slowed down recently, it's essential to remember that even giant companies like Amazon have growth cycles.

Amazon, for example, started as an online retailer. Its growth declined in some years but picked up when they launched new services like Amazon AWS. So, while Amazon's retail business slowed, AWS powered its future growth.

My point is, innovative companies continually launch new products to fuel future growth. Even if we're seeing some slowdown in Tesla's growth, it doesn't necessarily signal the end. It could be an opportunity for Tesla to launch something new that reignites its growth.

Tesla has been on quite a journey over the past 13 years, starting from a bold dream with just the Roadster to a lineup of several successful models like the Model S, X, 3, and Y. Sure, there have been bumps in the road, like capacity issues and factory shutdowns, but the growth has mostly been impressive.

Recently, the growth has slowed a bit, dipping to just 8% in the last quarter. That's a change, and it's natural to ask, "What's up with that?" For some perspective, I like to compare Tesla to Amazon. Back in 2010, Amazon was also mostly a one-trick pony with its online retail business. They had good years with growth rates as high as 40%, and then it slowed down. But hey, here's the kicker: they introduced Amazon Web Services (AWS), and boom, growth picked up again. So even if Amazon's retail growth has slowed down to around 8-10% per year recently, AWS has been a game-changer for them. Almost all of Amazon's profit today comes from AWS!

The takeaway? Innovative companies don't just sit there; they come up with new stuff that powers their future growth. So, even if Tesla's growth is slowing a bit now, don't count them out. Just like Amazon, Tesla could surprise us with something new and exciting. In short, a slowdown isn't necessarily bad; it could be the calm before a new innovation storm! Feel free to ask any questions or offer your thoughts.

For Tesla, with new products coming online, which I'll discuss later, we should expect to see acceleration. Okay, let's look at the price-to-sales ratio. Right now, it's about eight for Tesla. If you compare this with the auto sector, it's anywhere between 0 to 1. For high-growth tech companies, a price-to-sales ratio of 5 to 10 is considered reasonable. Tesla doesn't have the margins of tech companies, so it's somewhere between auto and tech. But if you look at Wall Street darlings like Nvidia, whose price-to-sales ratio is 32, it's clear that Wall Street expects Nvidia to keep growing for a long time.

Regarding Tesla's operating income per share, it's either increasing or stabilizing. The overall revenue is growing, and Tesla is now a profitable company. It's not just a loss-making entity that will continue to burn money.

Why am I still bullish on Tesla? Electric vehicle growth has been phenomenal over the last 10 years, growing at 50% or more every year except for one. Yet, electric vehicles only make up around 8 to 9% of total auto sales worldwide. With 90% of the market still non-electric, and regulatory tailwinds in Tesla's favor, growth prospects look strong. Recent regulations, like California's ban on new gas-powered cars after 2035 and similar moves by other states and the European Union, all point towards favorable conditions for Tesla. Tesla still operates like a founder-led company, even if Elon Musk didn't technically start it. It's the only global electric vehicle company, and its entry into China actually boosted Chinese electric car companies.

Tesla has several products in the pipeline, although they haven't been as quick to launch them, largely due to battery supply constraints and factory production. These include the Cybertruck and the Semi truck. Tesla can capture new markets here, as well as in robots and batteries. Tesla's advantage is that it operates like a software-first company. Elon Musk, who effectively serves as the founder, is a software guy. Overall, the tailwinds are in Tesla's favor, and I anticipate fast growth until at least 2035.

Being a software-first company, Tesla has so much more to offer. For instance, if you ask any Tesla owner, they'll say their cars get better over time, which is unheard of. Cars are known as depreciating assets, but we bought a Tesla and every month or so there is a new feature we can use. One anecdote from many years ago when the Model 3 was launched highlights this. Consumer Reports tested the Model 3 and said everything was great except for the braking system. Elon Musk saw this and within 24 hours, Tesla released a software fix for all the cars to improve the braking distance. Any other auto company would have had to bring the cars back to the dealership for a mechanical fix.

I've owned a Tesla for a year and a half now. Even though there have been some recalls, I've never had to take the car in; they can fix almost all problems with just a software push. This is a huge tailwind for Tesla. Another advantage is their charging network. Every major automotive company, except maybe for Ford, has opted into Tesla's charging network. About 20 to 40% of electric car charging will still happen outside of home, and Tesla dominates there.

As for headwinds, legacy car companies are launching electric vehicles, but they're not that good. For example, Ford's Lightning is not selling as much, and GM has stopped producing electric cars for a while. Chinese manufacturers might take over the lower end of the market, much like Android has done with phones. But as customers graduate to higher-priced options, Tesla will capture that market.

Tesla benefits from being in a free-market economy, unlike Chinese companies, which face restrictions and compliance issues. Another headwind is CEOs being spread too thin. Elon Musk is involved in Twitter, SpaceX, The Boring Company, Neuralink, and more. At some point, this could stretch him a little too thin.

I don't know where that line is—maybe it's already there—but on the other hand, the guy has launched rockets into space. I do believe in his abilities, but he is spread too thin. What if he has a heart attack? For instance, if he dies tomorrow, I think Tesla will be severely impacted. If robot taxis or something like that becomes the norm, then the overall demand for cars could reduce. I haven't put that in my model, but it's potential—like five years down the road, people might not need as many cars. Any questions so far? Anything you want to contribute? Okay, let's keep going.

A lot of people ask me, "Which one is the next Tesla?" I thought about it quite a bit. There was a company—its CEO is in jail, and it's close to being bankrupt—named Nikola. They were fraudulent. During the 2021 SPAC boom, several electric car companies went IPO. Some didn't even have a product. Lucid is still an old one, started by the original designer of the Model S, and they're not doing great. Their orders are getting reduced, and demand is slacking off.

My point is just like Google dominates search, and Facebook dominates social media; Tesla could dominate electric vehicles. Software plays a huge role in this, just like Apple making most of its profits in mobile phones. Cars are becoming like smartphones. iPhone is the premium product; Android is for the masses, and over time, iPhone keeps taking a little bit of share and most of the profits. Software is the difference.

Here's an interesting anecdote from my time in the software industry during 2020-2021. The demand for semiconductor chips went through the roof. I was working at Square at that time, and we used multiple chips in our payment readers. We had to reduce the number of chips in our product because of the shortage. Square was able to do this, and the hardware worked even better than before. During this time, Tesla didn't stop production. Other car companies couldn't produce cars due to the chip shortage, but Tesla adapted.

Ford's CEO said their car software is written by 150 different companies, and they don't talk to each other. Imagine trying to herd 150 companies to agree upon certain things. Tesla doesn't have to do that. So, that's my take on it. Would love to hear your thoughts if you have different ones.

I think there were a few parts missing, but overall, they didn't have to shut down their assembly lines because they were able to modify the software quickly. Ford, GM, Volkswagen, Mercedes, BMW—they can get there, but I think the chances are less than one in ten. A company that starts with software at its heart has a much bigger advantage compared to a company that starts with mechanical parts and tries to combine them through software. This is the same with IBM; it launched its first operating system for PCs but never became a champion because it was too rigid.

Robo-taxis could become big. Cruise is part of GM, and that's a big negative for them. Waymo is Google's project, but it's too early to tell which one will become a champion. Could Tesla become that? I'm not sure, but there isn't a clear winner right now.

So, what's my conclusion? If you believe Tesla will take the "winner-takes-all" approach, like Apple, Google, Facebook, and Microsoft did, then Tesla will go up in the long run—maybe even become a five trillion dollar company. If something happens to Elon Musk, and Tesla just becomes a car company, then it's a $200 billion company, max. At Xillion, we encourage you to think about the industry in your own way and then make a decision.

Thanks, Chandan, for adding that the second biggest thing for Tesla as a moat will be the charging network. That could be a big revenue driver. If you have any questions on Tesla, feel free to ask. You can always reach out to me at gagan@xillion.co. We provide a list of stocks with great metrics that are likely to grow long-term. Feel free to explore that by creating an account on Xillion. You get one month free on Xillionapp.com.