Friday, November 01, 2013

Why You Should Dump Those Shares of Tesla Now

Any investor who has ever heard of Tesla (TSLA) is probably aware that the stock is currently up more than 400% so far this year. With gains such as that many people are continuing to jump onboard and ride the wave. But not so fast. Keep in mind that I like to follow Warren Buffet’s advice to be fearful when everyone else is greedy and be greedy when everyone else is fearful. However, aside from that and the fact that history has proven in most cases that extraordinary gains like this are eventually followed by a sudden and resounding crash, here are some cold hard facts you can take to the bank, or your broker while you place your sell order.
Seeking Alpha’s Ayush Singh has come up with a nice comparison between Tesla and other car manufacturers to illustrate how overvalued Tesla is currently.
The company expects to sell 21,000 cars in 2013 and is presently trading at around $165, which translates into a market cap of just under $20 billion. But, given the amount of cars Tesla sells, this valuation is too high to be justified.
Aswath Damodaran, a Professor of Finance at the New York University, may not be a household name, but he's made some of the most accurate share valuations in the recent past - predicting Apple's peak and Facebook's low, to name a couple. And now, after doing his math on Tesla, Damodaran concluded that Tesla is worth $67.12. When he came up with this figure, Tesla was trading at $170.62, and after working out a comparative index, I believe he may be right.
In this index, I compared Tesla's share price with its production and profitability and compared it against the other big guns of the automobile industry and this is how the results stacked up.
Company's Name
Market Capital
Unit Production
General Motors (GM)
9.288 million
Ford (F)
5.708 million
Toyota Motor (TM)
9.692 million
Honda Motor (HMC)
3.137 million
Source: Yahoo Finance, Bloomberg, Zacks and Author's Calculation
Hence, Tesla is charging close to $950,952 per car, which translates into around 14 times the actual cost of the vehicle under the assumption that it is free to manufacture! Given real operating gross margins of 13% on its $70,000-priced Model S, Tesla is generating about $9,000 in gross profit from each car that it manufactures. Despite that, investors are placing an irrational valuation of around $950,952 on every car! Going by such calculations, Tesla will need to enhance its production by 20 times in order to be twice as expensive as Honda, which is the next big car maker, on a value-per-car basis.
A 20-fold jump may seem far-fetched, but that is exactly what Tesla bulls anticipate and they expect it to happen before 2020. But even if the company somehow manages to multiply its production by a factor of 20, will it justify a market cap of $20 billion or will it have to sustain its growth for a longer period of time to justify today's share price?
Dana Blankenthorn has a strategy for Tesla investors based on the fact that even Elon Musk acknowledges Tesla is overvalued.
How you deal with this depends on the kind of stock owner you are. Traders may continue getting profits out of Tesla for some time, but they must be warned that, when the fall comes, it will be sharp and sudden. Careful attention must be paid to small technical moves, to any move regarding momentum, or you'll lose your gains in a heartbeat.
For investors who may have bought their shares in the first quarter of this year, when the price was less than one-third what it is now, the situation is different. You can sell less than a third of your present stake and have all your investment out of the stock.
While the company may not be worth today's $20 billion, it may well be worth yesterday's $5 billion. Sales have been doubling every year. Gross profit is 25%. These are unheard of for a mass manufacturer. You're betting that Tesla can indeed use robotic manufacturing technology and scale to bring the company into lower price points, and get ancillary gains through the battery business. These are not unreasonable assumptions.
But I wouldn't pay 50 times sales for that, which is what you're presently paying. On a fundamental basis, Tesla is in a bubble. Those who believe in fundamentals can take their profit and wait for the bubble to pop - although they may risk some remaining momentum gains - or take out their initial investment and know that, even after the bubble pops, they're in the clear.
If you were one of the lucky investors who purchased your shares earlier in the year, you should consider cashing out now while you’re significantly ahead. Alternatively you can decide to hold onto those shares, or even continue putting more money in, but doing so would be a very risky move, even if you have the ability to hang onto them for many years to come.

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