Share of Tesla (Nasdaq stock code: TSLA) Driven by RBC Capital Markets automotive analyst Joseph Spak’s sharp increase, it surged 8% on Thursday, setting another record high. The stock continued to soar on Friday. Spak upgraded Tesla’s stock rating from outperforming (equivalent to selling) to industry performance (holding). At the same time, he more than doubled the target price to $700.
The analyst gave two main reasons for this change of mentality: Tesla’s ability to raise funds at low prices and the increase in growth expectations for the next five years. However, no reason is unreasonable. Instead, this seems to be another case of analysts pursuing Tesla stock. In the past year, Tesla̵
Mixed expectations for growth
With the upgrade, Royal Bank of Canada has raised its estimate of Tesla’s vehicle deliveries in 2025 from the previous estimate of 1.3 million to 1.7 million. However, the new estimates still imply that Tesla’s growth trajectory will slow down sharply in the next few years.
Tesla reported last weekend that despite the COVID-19 pandemic that caused its main factory to stop production for about two months, it still delivered 499,550 vehicles in 2020, an increase of 36% year-on-year. As of a few months ago, Tesla has installed an annual production capacity of 840,000 vehicles, and is still increasing production capacity. On the company’s third-quarter earnings conference call, an analyst asked whether this means that Tesla is likely to deliver 840,000 or more cars in 2021.
Spak’s 2025 delivery target is based on the 840,000 deliveries in 2021, with a compound annual growth rate of 19% in the next four years. In contrast, roughly speaking, Musk’s goal is a 50% annual growth rate. So far, he has basically achieved this goal. According to this growth rate, Tesla will deliver about 4 million cars by 2025.
Spak and his team believe that if Tesla’s stock will continue to grow at a rate of 40% to 50% per year for the foreseeable future, then their market value will exceed the rest of the auto industry combined. However, there is no reasonable argument to give Tesla stock such a high valuation based on RBC’s goals, which implies that the electric car pioneer will still have less than 3% of the global market share in 2025, and since then From then on, the growth rate will slow down rapidly.
Circular on valuation
RBC analysts also pointed out that Tesla can raise funds very cheaply by selling stocks in 2020. They believe that this low-cost cost of capital is a huge competitive advantage, enough to prove that the market value of Tesla’s stock is 8 times its sales in 2025. The reason for this is that Tesla will be able to use its stock to fund growth investments and acquisitions without having to rely on internally generated cash flow.
However, this argument is clearly based on circular logic: Tesla’s stock price is high, and the high stock price makes it possible to raise funds cheaply; therefore, if Tesla’s stock price falls by 75% for any reason (or no reason at all), then This argument works in reverse. The sharp drop in Tesla’s stock price will mean that the company can no longer raise funds at a low price, thus justifying the low stock price.
A warning sign for Tesla stock?
Positive assumptions are made about Tesla’s future market share, the profitability of electric vehicle production relative to traditional car manufacturing, and the potential for auxiliary business opportunities, which may prove Tesla’s high valuation. Following the recent surge in Tesla’s stock price, Tesla’s fully diluted market value is close to $1 trillion.
However, Spak and his team of RBC analysts expect Tesla’s growth to slow significantly in the next few years, based on their latest estimate of 1.7 million vehicles delivered in 2025. Therefore, from the perspective of fundamental analysis, the recommendations and price targets of brokerage firms seem to be completely unrestricted. Analysts seem to be increasingly chasing Tesla’s stock price, raising the target price just because the stock price has soared.
This logic can proceed in both directions. Tesla looks like a bubble stock, rising due to sheer momentum and fear of missing out. When the bubble bursts, Tesla’s stock price may fall sharply. These analysts may exacerbate this correction due to the downtrend of the same analysts who have been eager to raise their price targets in recent months.