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- Is Tesla an Extraordinary Company?
Dear Investors,
Tesla’s stock price was up 26% in the past 4 days.
You might be thinking that Tesla is extraordinary and having some feelings of missing out (FOMO).
But here at ROA, Extraordinary has a very specific meaning. It refers to the rare breed of company that creates value for shareholders while growing and that is run for the benefit of shareholders, not management.
Let’s try and figure out if Tesla is extraordinary.
A dude with a halo and a Tesla
Introduction
Elon Musk is a modern day business hero. He is launching rockets into space at Spacex, Tesla is leading the electric car revolution (maybe), Starlink is a global satellite communication network, he is supporting US presidential candidates and he owns a social media network (i.e. Twitter now called X), etc.
People idolise Elon. He can almost do no wrong.
This creates a halo effect. A halo effect is the tendency for an impression created in one area to influence opinion in other areas.
Because you think Elon is amazing, you might feel that Tesla is a great company to own. This is very dangerous thinking for investors and it can lead to poor investment decisions.
Fortunately, here at ROA, we’re not exuberant, we're mathematical. That actually makes us sound boring. Maybe should call ourselves The Boring Company? Oops, we can’t do that because Elon already has The Boring Company, which digs tunnels.
Jokes aside, lets take a cold, hard look at Tesla.
Myth busting
Before digging into the numbers, let’s bust some myths.
Myth | Reality |
|---|---|
Tesla invented the first electric car. | The world’s first electric car was the Flocken Elektrowagen invented in 1888. |
Spacex and NASA are pioneers at launching rockets into space. | The first rocket in space was launched by Russia in 1957. |
Starlink is the first global satellite communication network. | Iridium launched its global satellite telephone service in 1997. |
Financial performance
What do the numbers below tell us? The first clue comes from revenue growth. Over the past 5-years Tesla has grown revenue by 36.7% on average. That is very high revenue growth, so we know that Tesla is a growth company.
But in order to be an Extraordinary Company, we also want high returns. If we look at the return on capital employed (ROCE), you will see that it has been up and down and averaged 11% over the past 5 years. If you're a long time ROA reader, you know our rule-of-thumb is that above 15% is very good. Bad news, Tesla is not looking too good on that count.
But free cash flow (FCF) is the most important thing, so lets look at the FCF margin. It has averaged 3.7% over the past 5-years. That is well below the S&P500 FCF margin of 15%. Tesla is not looking good here either.
Capital expenditure is the amount invested in fixed assets in the business. In relation to operating cash flow, Tesla's 5-year average capex spend is 57%. That is quite high in relation to the S&P500 expenditure of 34%. But this is understandably high because the company is growing.
Stock based compensation (SBC) is where stock is used to pay employees instead of cash. In the long-term it has a negative effect for shareholders because bits of the company are being given away to staff. As a percentage of free cash flow, SBC has averaged 52% over the past 5-years. That tells us Tesla gives a lot of stock away. Not good.
Tesla financial analysis
In terms of valuation, Tesla currently sells for 506 times free cash flow (i.e. Price/FCF = 506). It has an enterprise value to EBITDA ratio of 64 (i.e. EV/EBITDA = 64). These numbers are extremely high.
For comparison, Apple (the most valuable company in the world) has an EV/EBITDA ratio of 26 and a Price/FCF ratio of 29. Admittedly, Tesla and Apple have different growth prospects and are in different industries. Nevertheless, this comparison puts the magnitude of Tesla's valuation in perspective. Tesla is very highly valued.
Stock price performance
Tesla’s stock price has been volatile over the past few years. Here are the returns over time:
1-year: 24.18%
3-year: -3.88% per annum
5-year: 68.08% per annum
10-year: 32.84% per annum
The 10-year performance has been stellar. The 3-year performance has been dismal. The recent 26% jump (since 23 October 2024) is almost insignificant if you're a long-term shareholder.
Tesla stock price
Good company vs good investment
At this point you might be feeling a little confused. You’re picking up the vibe that I'm saying Tesla is not Extraordinary, but the long-term share price performance has been amazing.
There is a difference between a good company and a good investment (we discussed it here).
Tesla is a growth company and it might be a good investment. Growth investors might love it (we discussed growth investing here).
But we are not Growth Investors, we are Extraordinary Investors (we discussed that here). That means, we want to find rare and special companies that have already proven their ability to create value for shareholders.
Conclusion
Tesla is not a bad company, it had glimpses of greatness between 2018 and 2022. But at the moment, Tesla is not an Extraordinary company by our definition. That doesn't mean it cannot become one in future.
This brings us to the importance of having an investment philosophy (we discussed it here). When you come across companies that have fantastic share price performance, you can be tempted to invest.
At those moments, it is important to evaluate the company in terms of your investment philosophy. If it doesn’t fit, let it go because you don't understand why you're investing in it and you will struggle to hang on when the stock price underperforms.
Here are the links we mentioned today:
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