Tesla isn’t an attractive investment now — not just because of the stock’s high valuation but also because it fails a basic quality test, which I shamelessly borrowed from Warren Buffett: Would I own the shares if the stock market were to close for 10 years?
Think about the next 10 years. You can draw an upward-sloping stock-chart line for Tesla
into the next decade and drool over the rosy vision of Tesla’s future that CEO Elon Musk has painted — produce half a million Model 3s and bunches of electric Tesla Semis and roadsters, and then send a roadster to Mars (I kid you not; that is in his 2018 plan.
Before you do that, though, think about another version of the next 10 years: higher (maybe much higher) interest rates, a recession in the U.S. and around the globe, and a less-forgiving bond market where Tesla would have pay a substantial premium to Treasurys (as would any other company that loses over a billion dollars a year in a highly cyclical industry).
Now answer this: Would Tesla survive this change in economic weather if it happened next year, or even three years out? The answer is a weak “maybe” at best, and “unlikely” at worst.
The counterargument: the U.S. and the world are not going into a recession. Actually, that’s not true; it’s just that nobody knows when. But after nine years of appreciating stock markets and tepid economic growth, investors tend to forget that recessions are a regular fact of economic life, usually arriving every four- to five years (so we are overdue). Most millennials have yet to navigate a job and a family through a recession. They have also never had to borrow at high interest rates — but that is liable to happen, too.
If you own high-quality companies, ones that meet Buffett’s 10-year stock market closed rule, you don’t have to spend a lot of time and energy thinking about when the recession will hit. However, if you own Tesla stock you’d better have a shiny crystal ball that will reveal lots of detail about the direction of interest rates and the global economy.
Recessions are tough for deeply cyclical companies like Tesla. The bulk of their costs are fixed, and accordingly lower sales usually result in significant declines in net income and often lead to losses. This is why car companies and their cyclical brethren don’t trade at high price-to-earnings levels when the economy is doing well and their earnings are high. The market doesn’t usually take these high earnings at face value, knowing full well that there are lower earnings (or losses) when recession comes. Tesla doesn’t have to worry about this low price-to-earnings problem, because in spite of its $50 billion market valuation, it has no earnings, just losses. It trades at whatever price-to-future Musk tells you it does.
One additional but important point. In the past I was dismissive of traditional automakers’ ability to compete with Tesla. I felt their 100-year history of producing internal combustion engine (ICE) cars was going to hold them back. For a while it looked like I was right about cars, as Detroit’s Big Three had a hard time saying goodbye to ICE. However, the future lines of electric cars coming from U.S. and German automakers in particular show that automakers are severing the connection to their ICE past and embracing electric.
So if you own Tesla stock and you only see one rosy (Musk) version of the future, you are ignoring the reality that today’s benign economic and business environment will not last.
Disclosure: I am an unsecured lender to Tesla through my $1,000 deposit on a Model 3.
So, how does one invest in this overvalued stock market? Our strategy is spelled out in this fairly lengthy article.
Vitaliy Katsenelson is chief investment officer at Investment Management Associates in Denver, Colo. He is the author of “Active Value Investing” (Wiley) and “The Little Book of Sideways Markets” (Wiley). Read more on Katsenelson’s Contrarian Edge blog.