Is the bull market back? Tesla (TSLA -1.85%) investors seem to think so. After going on a multi-week streak, shares of the electric vehicle (EV) maker are now up a staggering 131% this year, giving it a market capitalization of $782 billion and adding hundreds of billions in value in just a few short months.
Yet, the stock is still down significantly from all-time highs in 2021 when, in what seemed like a fever dream at the time, shares went vertical and hit a market cap of over $1.2 trillion. This made Tesla one of the most valuable companies in the world.
Optimistic Tesla shareholders like Cathie Wood think the 2021 party is about to get kicked into overdrive again. Her price target of $2,000 compared to the current price of $250 implies that a ton of gains are left for Tesla shareholders. Are these optimistic bulls correct, and is Tesla headed for a market cap of $1 trillion again?
Let's run the numbers and see if this makes sense from a fundamental perspective.
An incredible run start to 2023
Along with Nvidia's soaring stock, this bull run by Tesla is one of the fastest price returns from a mega-cap company in stock market history. But Tesla shares are still off 39% from their high point during the pandemic bubble of 2021:
It wouldn't be surprising to see Tesla's stock regain a trillion-dollar market cap this year. Investors across the board are extremely optimistic right now, and it would only require another 30% pop from the stock to get there. Over the last month, it has gone up in value by 50%.
But should an arbitrary price hurdle mean anything to you if you are an investor focused on the long haul? I don't think so.
Who cares about $1 trillion?
If you are an investor in Tesla, a trillion-dollar market cap is meaningless to you in a vacuum. All that matters is whether Tesla will generate more in excess cash flow than its current enterprise value at some point in the future, discounted back to today. Cash flow is the only thing that drives shareholder returns in the long run and is what all investors should be focused on. Betting on whether a stock price will jump 30% in a month is just a guessing game and will not work out for you.
In other words, you need to ask yourself: Will Tesla generate enough profits to warrant a trillion-dollar market cap (or higher) sometime in the near future? Consider that in 2022, Tesla generated a net profit of $12.6 billion on $67.2 billion in revenue, giving it a profit margin of 19%. This is well above the typical margins for automakers of 5% to 10% and is a key reason why Tesla's stock has soared in recent years. If it can keep a margin of around 20% and grow to hundreds of billions in revenue annually due to the boom in electric vehicle demand, one could argue Tesla's stock deserves a market capitalization of $1 trillion.
The problem is, these margins don't look sustainable and are headed in the wrong direction. Tesla has slashed prices around the world multiple times this year. All else being equal, these cuts will lead to margin compression on the income statement and less cash-flow generation. Car prices have started to fall across the board, and Tesla is feeling the worst of this pain. For reference, overall used car prices are down 4% year over year in the United States. For Tesla, they have fallen 31.6%, which is why it has had to cut its new car prices by 20% or more.
In the first quarter, Tesla's net margin fell to 13.3% and could be headed for 10% or lower due to recent price cuts that were not fully reflected in the Q1 results. A 10% margin on $300 billion in revenue in 2030 -- which would give Tesla half of the projected global electric vehicle market -- equates to $30 billion in annual earnings. That would be a forward price-to-earnings (P/E) ratio of 33, which is well above the long-term market average and would still only be achieved five to 10 years from now.
If you own or are thinking of buying Tesla shares at close to a trillion-dollar market capitalization, you need to be extremely optimistic about the company's revenue growth and profit margin potential. Otherwise, this looks like a terribly overvalued stock.
Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Nvidia and Tesla. The Motley Fool has a disclosure policy.
