Tesla stock: $4 trillion target red flag (NASDAQ: TSLA)

Yesterday, You’re here (NASDAQ: TSLA) released its third-quarter results, beating EPS but missing revenue. The quarter was marked by a number of issues, including supply chain issues in China, Twitter (TWTR) and inflation.

You’re here the stock fell 6.5% after hours shortly after the release of the statement. Most likely, the sale was a reaction to Elon Musk’s comments on the call rather than the actual numbers. The top and bottom measurements were mixed; basically earnings exceeded expectations. Additionally, TSLA rose in the first few minutes of after-hours trading, while the MarketWatch the table below shows.

However, after-hours trading turned sharply negative just minutes after markets closed. Elon Musk made a number of statements during the earnings call that likely rattled investors. These included:

• Admitting he paid too much for Twitter.

• say he was “unsure if China’s COVID lockdowns would ease.”

• Claiming Tesla shares could be worth more than Apple (AAPL) and Saudi Arabia combined.

The last item on this list may sound bullish, but you need to consider it in context. Elon Musk has faced a lot of criticism based on the idea that his Twitter deal puts downward pressure on TSLA shares. Many of Musk’s biggest supporters voiced this criticism, and Musk himself sold a huge number of shares.

Given this, it’s hard to avoid considering the possibility that Musk is trying to drum up excitement around Tesla stock to offset the effect of his own sales. In fact, that’s exactly what MarketWatch author Therese Poletti suggested in her article, “Elon Musk is pumping up Tesla shares with a ridiculous $4 trillion target. Does a dump come next? » In fact, she even hinted in the title of the article that more sales were expected.

It’s entirely possible that Musk will have to sell more Tesla stock to buy Twitter. Recently, Barron’s floated the idea that funding for the deal could collapse. Barron’s article also indicated that Musk would be allowed to walk out if the funding failed, so the coverage wasn’t entirely bearish. Still, there was a strong implication that Musk would continue to sell stocks.

Overall, Tesla looks much more attractive now than it did in the past. At today’s prices, it trades at 50 times earnings and 49 times cash flow – multiples which, while high, are not higher than the P/E ratio. Amazon (AMZN) has supported for decades. A fast enough growing tech stock may warrant high multiples, although it must be said that the current high rate environment does not encourage such bets. For this reason, along with the possibility of Musk selling more stock, I view Tesla as short to medium term “holding”.

Why the $4 trillion prediction is a red flag

Musk’s $4 trillion Tesla stock price target is a red flag, not because it’s impossible to achieve, but because it signals that Musk feels an urgent need to ‘energize’ the TSLA stock. This in turn could imply that he planned more sales. Musk selling stocks by itself poses no risk for long-term investors, but it is a risk for those with short to medium-term time horizons.

Elon Musk owns about 25% of Tesla shares, worth $173 billion. The Twitter deal is $44 billion. According to Bloomberg, Musk has sold $32 billion worth of Tesla stock since the deal was announced. If the financing failed and other investors bailed out, he would have to sell an additional $12 billion in stock to complete the deal. This would put appreciable selling pressure on TSLA, which would likely lead to its downfall. $12 billion represents approximately 1.7% of Tesla’s market capitalization and 60% of one-day dollar trading volume. So there will be downward pressure on TSLA’s price if Musk has to sell.

None of this is to say that Tesla can’t reach a market cap of $4 trillion. Notably, Apple was once 75% of the way to that goal. Tesla’s revenue growth is currently 60%, if you slow it down to a third of the current level (20% growth), you still have the makings of a very valuable business. Tesla earned $1.05 in earnings per share (“EPS”) in the quarter, up 69%. Let’s say, conservatively, that growth will slow to 20% over the next 10 years. $1.05 compounded to $6.5 over 10 years at this rate. On a full year basis, it’s $26. With a multiple of 20 times earnings, we arrive at a stock price of $520. Multiply that by Tesla’s $3.063 billion in outstanding stock, and you get a market capitalization of $1.59 trillion. It’s 39.75% of the way. This is all based on a high growth assumption, but the assumed high growth is well below Tesla’s historical growth. So a market capitalization for Tesla somewhere in the trillions is not unthinkable.

What is Tesla stock worth in the long term?

Having looked at a short-term negative catalyst for Tesla stock, we can now ask what it is worth in the long term. In previous articles, I have used discounted cash flow models to arrive at fair value estimates for TSLA between $750 and $860. That was before the recent 3-to-1 split. It’s worth revisiting Tesla’s valuation again in light of the recent earnings release and stock split.

The tricky part of Tesla’s modeling is the growth. A company’s free cash flow is the product of many moving parts, including revenue, cash operating expenses, investment in working capital, and more. In the case of Tesla, these parts are mostly growing very quickly. We can come up with a basic model by carefully assuming where these various elements will go in the future.

Tesla’s revenue growth in the last quarter was 55%. It was 60% over the 12 month period. Conservatism demands that we reduce this number to account for scale effects. So I assume revenue grows at a CAGR of 20% over 5 years.

We now have the cash portion of the operating costs. These decreased by $1.5 billion. It’s nice to see costs come down, but I wouldn’t expect it to last – a lot of companies are saving money this year to deal with the recession, it’s something temporary. So I don’t foresee a continued decline in costs, but I will assume that they grow more slowly than revenues, to account for management trying to keep them under control. So I guess they go up 10%.

Finally, we have the other elements of free cash flow: investments and working capital. Tesla’s CAPEX growth has slowed significantly while its net working capital has fluctuated between positive and negative, so I assume these elements remain collectively unchanged from the baseline. From there, I get the following model:

Click to enlarge

So we end up with $72.5 billion of free cash flow. With today’s share count, that works out to $23.69 per share. This is a CAGR growth rate of 59.8% from the current $2.26 in FCF per share. If we assume no growth after the five years of growth and use a discount rate of 6%, we end up with a price target of $338. The market capitalization at this price would be over $1 trillion, but nowhere near $4 trillion. Musk’s predictions will not be met in five years based on this model. The model does, however, suggest that Tesla has an advantage, so it may be worth taking a look at for investors with long-term horizons.

A big risk to keep in mind

As we’ve seen so far, Tesla stock faces short-term headwinds but has long-term potential. Whether it’s investable really depends on your time horizon – for my money it’s just a hold.

If you choose to go long in Tesla, the main risk factor you should keep in mind is the possibility of supply chain disruptions in China. Elon Musk has bet big on China, where he not only manufactures, but also sells his cars. Tesla’s operations in China are very lucrative for the company, but they are also risky. China’s zero-COVID policy led to a slowdown in production at Tesla’s Shanghai factory in the second quarter. Xi Jinping recently signaled at the Chinese Party Congress that he will not end zero COVID, so this remains a risk to watch.

The essential

The bottom line about Tesla is that it’s a real company whose stock has non-zero value. In fact, even if you assume that Tesla’s revenue growth is more than halved, it still ends up being worth more than what it’s trading for today. As a long-term bet, Tesla has a lot of potential. I’m not sure I see a path to $4 trillion, but I could see it reaching $1.5 trillion.

The short term, on the other hand, is less rosy. If Musk pursues his Twitter deal, he could sell more shares, whether due to stalled funding or simply to avoid interest payments. Either way, it will be a negative catalyst, putting downward pressure on TSLA shares. It’s not the end of the world, but it’s something shorter-term minds should beware of.