The Meaning of Tesla
Tesla (TSLA) is a stock for the ages. But not in the way some would want.
Our hunch is that, 30 years from now, Tesla will be remembered like the South Sea Company, if not something worse (think Enron).
In Tesla, we are witnessing one of the greatest single-stock bubbles of all time, against a backdrop of speculative global frenzy.
It is far from just Tesla, of course. Whole sections of the market are going straight up, thanks to what the Federal Reserve is doing (and what the U.S. government is expected to do).
To give an example, with a market cap of nearly $2.3 trillion as of this writing, the valuation for Apple (AAPL) has also departed from planet Earth.
But Apple, at least, is a dominant consumer tech juggernaut with a monopolistic stream of cash flows. It is very hard to compete with Apple in its particular areas of dominance, and may not even be possible.
And so, to the extent investors bid the valuation of Apple to the sky, they are putting an extreme multiple on a bulletproof stream of cash flows.
With Tesla, something else is happening. To explain Tesla’s market cap via rational expectations, one has to anticipate, say, a monopoly of self-driving cars on Mars, or something comparably out-of-this-world.
The craziness of it all — and the unique nature of the moment — makes the Tesla phenomenon worth contemplating. If one asks the question, “What is the meaning of Tesla?” there is more than one interesting answer.
To start, Tesla, in our view, provides the textbook definition of a “bubble.”
There are different ways to define a bubble. The most logical definition, in our view, comes from the well-known quant investor Cliff Asness, who put it like this:
“The term ‘bubble’ should indicate a price that no reasonable future outcome can justify.”
The question is whether a plausible case exists for growing into the outlier expectation. If it is at least possible, within the bounds of reality, for the asset to achieve the implied valuation — under some kind of best-case circumstance — then it isn’t a bubble. It is just the market pricing an edge-case scenario.
Sometimes, though, it is not at all possible to justify a valuation.
When you can’t get from here to there — barring some ridiculous assumption, like the company discovering nuclear fusion, or having all of its competitors disappear — you have a bubble.
Tesla makes fewer than 400,000 cars per year. Toyota makes 10 million cars per year. And somehow Tesla is so valuable it should fit Toyota inside it almost 2.5 times over? No.
Trying to rationalize Tesla’s market cap of $442 billion is an exercise in pure silliness, unless one is doing it for the fun of it.
Not only does Tesla have something like 1% of the global auto market, it is nowhere close to dominating the electric vehicle (EV) market — its main area of focus.
Europe is one of the most competitive EV markets in the world, says Mark Spiegel of Stanphyl Capital. According to Spiegel, Tesla’s market share of EV sales in Europe has fallen by more than two-thirds over the past year, from 30% to single digits.
Not only does Tesla face brutal competition in the EV space, those competitors are ramping up.
Somehow, Tesla is supposed to become more profitable than any other car company that ever existed, which would require levels of dominance in the EV space that crowd out virtually every other competitor, even as tens of billions are pouring into the space as Tesla’s market share declines.
Rational? No. Not on this planet. That is because Tesla is in what might be a hyper-bubble.
Returning to cash flows, compare Tesla’s income and profit margin to Visa, a top-10 S&P 500 stock with a market cap comparable to Tesla’s (both are in the $450-$500 billion range as of this writing).
As finance blogger Jesse Felder reports, Visa had $11.8 billion worth of revenue last year, whereas Tesla had $400 million.
So, Tesla has a market cap comparable to a company — again a juggernaut with bulletproof cash flow streams — with revenues 30 times its size.
But the comparison gets worse: Because the payment processing business is so profitable, Visa’s reported profit margins are a gorgeous 51.4%. Tesla’s margins, meanwhile, are just 1.4%.
And yet, the story gets even sillier.
DataTrek Research, a Wall Street firm, is skeptical that Tesla will be included in the S&P 500 any time soon — as many bulls assume — because virtually all of Tesla’s net profit over the past few quarters was based on selling environmental regulatory credits, versus, you know, making money by selling cars.
So yes, Tesla is a bubble. Of that there is zero doubt. Trying to pretend otherwise is an exercise in folly.
But that is only the start of what makes Tesla interesting, because of what we can learn from Tesla, in real time, about the nature of bubbles.
For one thing, Tesla further confirms the efficient market hypothesis (EMH) is a joke. The notion that markets are always and everywhere rational has always been a joke, and for decades the joke has been laughed at.
In his excellent book Complexity: The New Science at the Edge of Order and Chaos, science writer M. Mitchell Waldrop describes the founding of the Santa Fe Institute, a groundbreaking institution dedicated to interdisciplinary study.
At one point, as the Sante Fe Institute is getting going, the world’s top economists and the world’s top physicists get together to share ideas and perspectives.
When the economists describe the efficient market hypothesis — which the physicists had never heard of before — the physicists literally break out laughing. One of them asks, “you guys really believe that?”
(This actually happened, more than 30 years ago. Waldrop’s book is an excellent read.)
In addition to confirming EMH is silly, Tesla confirms something else: Standing in the way of a bubble is crazy. The bears who were short Tesla, with no protection, learned this lesson the hard way.
When a stock enters true bubble territory, there is no longer a ceiling or a floor. All rational yardsticks are lost in terms of how high the price can rise, and subsequently how fast it can fall.
Think about it: If the earnings multiple has ceased to matter, what is the difference between 200 times earnings and 400 times earnings? There isn’t one. If the stock is no longer trading on an earnings basis, the multiple is just a meaningless number. It can go anywhere.
This also works on the downside, however. A stock with a crazy multiple can fall by 50% and still be wildly overvalued, to the extent that half of crazy is still crazy.
Bubbles are truly postmodern in this sense. In a bubble, prices can mean whatever investors want them to mean, and turn based on mood or sentiment with lightning speed.
Tesla demonstrates how flow itself can be a fundamental factor. All of these things are connected.
In other words, if a stock with a red-hot bubble valuation can be brilliantly marketed — and Elon Musk is one of the greatest hype men of all time, if not No. 1 — then so much capital can flow into the stock that the flow itself may change the outlook for the company, and the share price.
Consider the following chain of events:
- Tesla’s share price rises so high that a 5-for-1 stock split is announced on Aug. 11.
- The stock split is a nightmare for the remaining Tesla bears who are short. For logistical reasons, it is a huge pain to be short a stock heading into a split.
- Retail anticipation of the stock split as a bullish event, coupled with an intense round of short-covering for the remaining shorts, drives Tesla’s share price up another 50%, just because of the split announcement, in a matter of days.
- As Tesla’s market cap soars, the company announces a fresh capital raise of $5 billion, which will then pad operations (which still aren’t profitable apart from selling those regulatory credits) for the foreseeable future.
Last but not least, Tesla’s behavior is a classic demonstration of how new technologies are funded.
When an exciting new technology comes on the scene, with the potential to transform industries or entire economies, investors do not allocate a modest trickle of capital to that technology in a sober and thoughtful way.
Instead they tend to cannonball into the space, flooding it with money in such a manner that most of the funds are wasted. As a result of this flooding in, a great many companies pop up that are destined to go bust, with perhaps 95% of all the capital invested going up in smoke.
But then, after the smoke clears, perhaps 5% or fewer of the companies that were funded — and sometimes just a handful — wind up actually taking the technology through a long tail of development, with an ultimate result that changes the industry, or even the economy, as promised.
We saw this with the dot-com bubble, where most of the highfliers of that era were a total bust, but Google, Amazon, Paypal, and eBay emerged.
We saw it earlier in the 20th century with airlines, and still earlier with plane manufacturers and car manufacturers in the aftermath of the Wright brothers and Henry Ford. Then, going to the 19th century, we saw it in the transcontinental railroad boom of the 1860s.
Over and again, you see a particular technology — in this case electric vehicles — receive a torrent of enthusiastic funding, with the leaders getting wild valuations near the peak, and the majority of also-rans going bust. Based on human nature and centuries’ worth of track record, this just appears to be the way technology gets funded.
Will the Tesla bubble burst? Yes, though we have no idea when. As John Maynard Keynes once put it, “the market can remain irrational longer than you can remain solvent.”
But one of the final things we can observe is that bubbles, by definition, always come to an end (assuming the free market continues to function).
This is because a bubble cannot exist as a static thing. It has to keep growing in order to sustain itself. When the momentum snowball of confidence and capital flows stops pushing prices higher, the bubble asset is like a bottle rocket at its maximum point of trajectory distance from the surface of the earth. Unless it has escaped the atmosphere, gravity takes over.
There isn’t much point in trying to anticipate the bursting of a true bubble, though, because a bubble’s lifespan can run from months to years — or in rare cases multiple years, or even a decade or two. Even fraudulent operations can have surprisingly long lifespans: Think Enron or Bernie Madoff.
Instead, with a bubble, it makes sense to keep an eye on things, and watch for signs of deterioration in enthusiasm and sentiment — along with potential catalysts that could change the flow picture (like a drying up of credit conditions) and clues from the price action itself (like the breaking of a price trend).