What we are going to see today is bit advanced topic. Yellow category.
It is not easy to understand the valuation of a high growth company. When we look at the valuation of companies like Tesla, they are at crazy level.
Can we actually give that high of a valuation for a high growth company?
Or is it just the market pumping up the price for no reason? How can we analyze that?
We will do a sample analysis in this episode using Tesla as an example.
Hi. I am Vijay Mohan. You are watching - Investment Insights.
When it comes to Tesla, one group will say that it is extremely overvalued and we should not even go near it.
Another group will invest confidently saying that the game has just started and the main run is yet to come.
We are sitting in the middle confused.
Tesla's total value today is 1.2 Trillion US dollars.
Where do we get to know the value from? From Market cap.
Tesla's last one year is around $47 Billion. What does that mean? It means, Price to Sales ratio is at 25.
Seeing a company's value in the multiples of sales is called as "Price to Sales" Ratio.
The teashop example that we saw in last episode had 10 Lakhs as yearly sales and 10 Lakhs as value. That means its Price to Sales ratio is 1.
Because the value of the teashop is one multiple of its sales. With Tesla, that price to sales ratio is at 25.
It is as if the value of teashop is 2.5 Crores from sales of 10 Lakhs, Tesla's value is at 25 times its sales.
This is in sales multiple. How does that look like in earnings multiple? Earnings for last one year is around $3.5 Billion.
How many 3.5 Billions are there in 1.2 Trillion? 343. This is P/E Ratio.
Seeing the value of a business in the multiples of its earnings is "P/E Ratio". So Tesla's P/E ratio is 343.
Sales multiple is at 25. Earnings multiple is at 343.
Is that expensive or cheap? Looks expensive. How expensive is it?
To know that, we should compare Tesla to an equivalent company's value. What can we use? How about Toyota?
Toyota's sales multiple is around 1 and its earnings multiple is 9.5.
What does that imply? Market has given a value to Tesla that is 25 times over the value of Toyota.
Ok. Let's leave Toyota. How about we compare it with Apple?
Apple's sales multiple is 7. Its earnings multiple is 26. Tesla's value is many times higher even when compared to Apple.
So Tesla's value is definitely super expensive. There is no doubt about it.
Why is market giving very high multiples for Tesla? Is it fair value? What makes Tesla that special?
To understand that, we should dig deeper into Tesla. We cannot reject that it is expensive just by looking at sales and earnings multiple.
How fast is Tesla business growing? First let's check out its revenue growth.
Revenue has grown from 7 Billions in 2016 to 31.5 Billions in 2020.
So far in 2021, in 3 quarters, revenue is at 36 Billions. At least 15 Billion is expected as revenue in the last quarter.
That would mean, the total revenue for 2021 would be 51 Billions.
In 5 years, revenue has grown from 7 billion to 51 billions.
Remember the compound annual growth rate that we reviewed in last episode. Tesla's CAGR is 49%.
Tesla's management is targeting a growth of 50% as well.
Let's compare that to Toyota's revenue growth.
There is no growth in Toyota's revenue for the last 5 years. It is almost staying in the same value.
Market has given a sales multiple of 1X to Toyota as its revenue is stagnant.
As Tesla is growing at a rate of 50% every year, it has given a multiple of 25X as value. Is that a fair multiple?
If Tesla's revenue is growing at 50% every year, where would it be its revenue in next 5 years?
It will be at 387 Billions. It is almost 8 times that of Today's revenue.
Let's say that the share price is not increasing from Today's $1200 for next 5 years.
Then what would be the sales multiple after 5 years? 387 Billions out of 1.2 Trillion. Sales multiple will be at 3X.
25X looked very expensive. But now this 3X does not look that expensive right?
But market, does it keep the price same for a stock that has a revenue growth of 50% for 5 years?
As long as the revenue is growing at 50% and if the future growth has favorable environment like Today, market will try to maintain that 25X multiple.
What does that mean? To maintain that 25X multiple, share price will try to increase in the same multiples as revenue increase.
This 50% revenue growth alone is not the reason for that 25X sales multiple. There are others as well. Gross Profit Margin.
That is, how much profit does Tesla make from selling one car? That is "Gross Profit Margin".
Tesla's gross profit margin is improving every quarter. Last quarter it is 27%.
It is expected to go up to 40% in the future.
Toyota's profit margin is at 18%. Historically for many years, that is their profit margin.
Tesla does not follow the traditional manufacturing and assembly process. It saves significant costs just from that.
Also, there is no advertisement. So, no marketing budget.
Twitter handle of Tesla's CEO - Elon Musk is their marketing tool.
Just like how we have Birla Institute of Technology and Science (BITS), he said jokingly that he is going to start "Texas Institute of Technology and Science". Mischievous guy.
That kind of free marketing is good enough for Tesla.
Also, they don't have dealerships like other cars. They sell directly to the customers. They save money there as well.
That is why, Tesla's profit margin is expected to grow to 40% in the future.
What does that imply? The money made by Toyota by selling 2 cars will be made by Tesla by selling just one car.
That is when the price of both the cars are same. But we know that Tesla's cars are at least 25% more than Toyota's. More Price. More profit.
Just 50% revenue growth and expected 40% profit alone could justify the 25X sales multiple.
But Tesla's has more tricks up its sleeves as well.
The auto pilot FSD - Full Self Driving.
We have seen its capability in many YouTube videos. That too its latest version - just unbelievable.
Not just humans, it is identifying even a puppy and adjusting its path accordingly.
The pace at which this FSD is getting developed, it will not take long to get the full approved version. That would mean - Robotaxis.
Driverless taxis will start coming into the market. If that happens, nothing can stop Tesla. But it is unknown. Purely speculative.
As if these are not enough, they got Car insurance, Battery, Solar business that has huge future potential in their hand as well.
When looking at all these, 25X sales multiple does not look that bad at all.
Before you jump and buy Tesla stocks after seeing this rosy predictions, understand the risks as well.
Firs risk is - what if Tesla's revenue does not grow at the expected 50% growth?
If the growth gets slower than 50%, market will cut down the sales multiple from 25X depending on the amount of slowness.
Let's say that the revenue of Tesla for 2020 is growing only at 30% instead of expected 50%.
Then its sales will be at 66 Billions in 2022.
If the growth is slowing down from 50 to 30%, that is 40% less than the expectation.
Assuming everything else is same, sales multiple will reduce 40% from 25X to 15X as well.
Infact, if the growth is not up to the expectation, market can cut down the sales multiple even down to 10%.
That means, 10 times 66 Billions, 660 Billions will be its market cap.
That will be almost 50% less than Today's stock price.
So if the growth is not upto the expectation, we can expect the stock to go down even by 50%.
It will not happen exactly like this in the market. But I am saying this as an example to explain the price behavior in the market.
We can use this as a rough approximate calculation.
Sometimes, when we see a company's quarterly results, it will look phenomenal. But the stock price will go down.
Have you every wondered what is happening? This sales multiple readjustment is the reason.
If the growth of a company is not upto the market's expectation, stock price will go down.
If Tesla grows at 50% as we expect, then like I said earlier, stock price will try to maintain that 25X multiple.
In 5 years, if the revenue goes up by 7 folds, stock price could go up 7 folds as well.
But it is not that easy to maintain 50% growth for that many years.
When the growth rate starts slowing down from 50%, the sales multiple 25X will go down as well and eventually it will settle in 5X to 10X multiples.
It could happen in 5 years or in 10 years.
When we look at Tesla's business Today, they are about to open their giga factory in Berlin and Texas.
That means, car deliveries will definitely go up next year. Demand is also higher than the supply.
So they will achieve the 50% growth in near term easily.
How long can they maintain this 50% growth is, yet to be seen.
Competition is increasing in the market as well.
When Tesla has grown into an expert in the last 10 years in EV space, their competitors are just starting.
Remember the power of compounding. When their competitors jump 2 feet, Tesla would leap 4 feet.
It is not easy to catch up Tesla as many think.
Even if they catch up, EV sector is something that is going to grow exponentially in the future. As Tesla is the market leader, it has got the maximum advantage here.
So market has huge expectations set on Tesla. And so far, Tesla has been delivering more than the expectations.
But when it fails to meet the expectation, its share price will take a hit at that time.
All these are what I know about Tesla. There could be 1000 other things that is happening with Tesla.
We should never make an investment decision on an individual stock based on another's analysis.
There are close to 30 stock analysts who cover Tesla in the market.
Their share price expectation is from $67 to $1300. If the valuation is easy, aren't they all supposed to have similar price target?
They spend all their time in analyzing this. Even if they are not able to come to an agreement, how can we?
What I am trying to say is, Valuation is like Beauty. It is in beholders eyes.
So in a company, only you know what you are valuing in it. My opinion or so called "market expert"'s opinion does not matter.
If you are asking for an opinion from another person to invest in an individual stock, you should know immediately that you are not ready for individual stock investment yet.
It is better for you stay with an Index Fund.
This episode is to explain what are all the factors that you need to if you are planning on investing in a high growth stock.
Analyzing Tesla's stock is not the intention.
So please do not request to analyze any other stocks. That - you should do it.
My intention is to show you how to catch a fish from what I know.
But if you expect me to catch and fry it for you, Sorry. I am not person.
We will soon meet again in another episode. Thank You.