Introduction
This Financial Research Report presents a possible investment opportunity for a client interested in the US stock market. The company chosen for the client is Tesla Motors, Inc. Established in the year 2003 and went public in the year 2010, Tesla designs develops, manufactures, and sells its high-end electric cars and solar energy storage products in the US, Europe, China, and other global markets. Its flagship cars are mainly sedan and sports utility cars.
A rationale for choosing the company for which to invest
Tesla Motors, Inc. is the pioneer electric car manufacturer, which is viewed as a great firm given consumers’ enthusiasm for its sports utility, sedan cars, and solar energy storage products. The company’s Model S is highly evaluated while Model 3 got nearly 290,000 pre-orders.
Economic significant
Tesla is a company that has brought about major changes in the automobile industry. The established sales channels with no distributors and innovative technologies, including solar energy storage have deeper implications for both the energy and transport sectors. That is, Tesla is a company with innovative products and technologies with huge potential to disrupt significant fractions of the economy and enhance the US economic growth for many decades.
The firm is poised for growth, as will be seen in the stock analysis later in this report. The disruptive nature of this company makes it vital for the economy in specific areas related to employment and inflation and, therefore, of interest to any investors. Tesla has automated most of its manufacturing processes to save costs on human labor.
Also, it has significantly embraced new technologies to reduce the overall headcount in the factory – a move that has suppressed growth in wages. Of course, this approach has assisted the company to mitigate issues associated with skyrocketing labor costs and other uncompetitive labor practices. Consequently, it can save significantly on employee compensation and benefits.
Additionally, Tesla has embarked on disrupting the traditional model of a car dealership by focusing on online car sales, few showrooms, and almost no advertisement expenses.
Tesla is an exemplar of technological realization and its disruption in economies. Although the company has relatively a small production number relative to gasoline-fuelled cars, the company’s production capacity is expected to rise each year as demand increases. That is to say, the electric car market is growing steadily and rapidly than earlier anticipated.
Keen analysts and investors have noted that the number of electric cars on the road in the US will reach five percent by the year 2025. This project will ultimately shift oil consumption in the US and lead to a decline in oil demands. The reduction in demands will be attributed to a significant number of electric vehicles on the road, which would perhaps lead to low oil prices. Thus, Tesla will influence the economy in a significant manner.
Financial significant
Current financial reports indicate that Tesla is a loss-making firm, and it is not likely to be profitable until the end of the decade. Nevertheless, the company has continued to realize increased revenues because of year-over-year growing demands and sales.
For investors, Tesla does not pay a dividend. Instead, the company focuses on enhanced investment in research and development (R&D) to revamp its autopilot technologies, longer battery lives, and introduce new advanced models at affordable prices.
The continued investment shows that Tesla executives have better growth opportunities to invest earnings and shareholders’ funds. To this end, the financial significance of the company to the economy or investors is negligible, but it continues to shape the investment in R&D.
Relative to competitors, Tesla appreciates that its rivals have greater financial, marketing, manufacturing, and technical resources, which they can use to facilitate the production, sales, and promotions of new cars. Moreover, the company lacks massive financial resources generated from revenues because of less extensive customer bases and industry relations, limited operating history, and inordinate name recognition.
Tesla stock is, therefore, suitable for the patient, long-term investors. According to experts, Tesla stock offers an important opportunity for investors who are keen and can absorb some risks because it is one of the best long-term stocks currently available (Anderson, 2015).
As the share price continues to decline, long-term investors have a better buying opportunity. It also noted that the company has gained about 500% in share price since its IPO in 2010. That is, its IPO at $17 per share in June 2010 had achieved a maximum of $280 per share in 2014, but the current share price is around $220.96 (August 2016).
Other factors of consideration for the selected stock
For investors, Tesla should be more than an electric car manufacturer. One major reason that makes Tesla stock superior as a long-term investment opportunity is the company’s focus on the home battery segment of the market. The company has started the production of lithium-ion batteries found in its cars for capturing and storing solar power for domestic usages. This represents a critical shift for the company, which positions it above competitors.
Tesla now is strategically positioned in the middle of two emerging industries, electric, self-driving cars, and clean energy, which will move the company forward.
Further, the quality of leadership is also interesting. Elon Musk is now considered the most innovative, futurist CEO on earth. He can identify values that others have failed to recognize. Cars, lithium-ion batteries, solar, and innovative business models have all shaped entrepreneurship. The home battery, for instance, is meant for everyday use to allow owners to store energy and use during high-cost tariffs. The use of direct sales ensures that Tesla can maintain the required inventory around while simultaneously eliminating dealers with diverse business agendas (D’Allegro, 2015). Ultimately, the company cannot go wrong with such approaches.
Tesla is regarded as a disruptive technology firm. It boasts of superior technologies and qualified engineers, which give it a lead on other companies in the auto industry. Moreover, Tesla has maintained a growth rate of more than 50% every year in a relatively stable market. It is expected that Tesla will continue to deliver superior products relative to its Model S and competitors.
Given that Tesla still has low sales volume, it then has further opportunities for expansion. Further, the decline in prices of gasoline should not be a factor of concern for investors because the shift toward electric cars is not driven by gasoline prices. Instead, it is a general shift, which promotes environmental conservation. It is expected that by the year 2025, there would be more Tesla cars on the road than imagined (D’Allegro, 2015).
Tesla’s stock price will continue to improve as revenues rise. Hence, it is a good bet for investors.
The primary reasons why the selected stock is a suitable investment for the client
Tesla is a growth-oriented company, and so is the investor.
Tesla has demonstrated its potential since its launch in 2003. Today, the company’s gross margins have improved, and they could range between 25% and 30% by the end of 2016. Tesla is currently manufacturing about 2,000 Model S and Model X cars in one week. Further, the company focuses on a steady increment to attain a target of 2,400 by the end of the fourth quarter.
Tesla has also invested heavily in its Model 3, which is touted as an affordable model expected to provide sufficient volumes to drive operation profits. The CEO has stated that the volume of cars would triple or even quadruple once the company starts to ship Model 3. Further, mini-SUVs and buses based on the technology of Model X will soon reach the production stage too.
These developments form a company characterized by loss-making sound enticing for a long-term, patient investor. An investor must, however, recognize that these are ambitious targets, which Tesla may fail to attain as stipulated.
Nevertheless, the bottom line is that Tesla’s financial indicators will soon shift to profitability and, thus, it will become a vital investment opportunity.
A description of the client’s profile
The investor recommended for Tesla is a growth-oriented one. The investor will seek to optimize the long-term potential for price growth based on its principal. Tesla’s share price is characterized by price fluctuations, which the investor must tolerate while ignoring all the noise and squeak. The investor notably possesses a long-term investment period (Vanguard Group, Inc, 2016).
The investor is a billionaire whose primary goal is optimization. Current income generation is not the major objective of the investment decision. Thus, it would be imperative for the long-term growth-oriented investor to hold off on Tesla’s stock until the company starts generating profits perhaps after this decade (Mourdoukoutas, 2016).
The investor uses a patient method to invest, is a fan of the company, and believes in a long, thriving future of the company and the bold vision of the CEO. The investor understands that the loss-making trend will soon end, and Tesla will start paying dividends.
The investor is not a long-term value-oriented or immediate income-focused investor. Long-term value-oriented investors should consider other stocks in the auto industry such as General Motors stock or Ford’s stock. These investors would not find Tesla’s stock as attractive relative to other companies. Hence, they should not buy, but instead, sell Tesla’s stock to other investors. Tesla currently has negative operating margins and operating cash. According to these investors, the current state of Tesla reflects multiple weaknesses, which they consider as critical sources of investment challenges with greater consequences than any strengths that drive decisions of long-term growth-oriented investors. In this case, such investors find it more difficult to consider Tesla’s stock because they believe that other stocks are better options. Thus, net income and sustained growth in earnings per share are vital for such investors.
Analysis of Financial Ratios
Liquidity
Current Ratio
Total Current Assets/Total Current Liabilities
This ratio is vital for providing an overview of Tesla’s ability to repay its short-term debts with its short-term assets. Tesla Motor Inc. Current Ratio for the last three fiscal years is presented in the following table.
Source: gurufocus.com
It shows that the company is hardly efficient in its operations and, therefore, issues related to liquidity may arise. Generally, the acceptable ratio ranges between 1 and 3. Nevertheless, the industry average is imperative for comparison. While this ratio reflects the current financial challenges at Tesla, it does not necessarily mean that the company will go bankrupt soon.
Quick Ratio
Total Current Assets-Inventory / Total Current Liabilities
This ratio shows whether Tesla will be able to meet its short-term debts based on its liquid assets, and inventories are not included.
Source: gurufocus.com
For the past three fiscal years, Tesla has recorded declining quick ratios, which show that the firm is highly leveraged and fighting to grow and sustain sales. Hence, the declining trend is not healthy, and Tesla may not cover its financial obligations.
Earnings Per Share
Diluted earnings per share = Net Income-Preferred Dividends / Total Shares Outstanding
This ratio reflects the value of earnings per outstanding share of Tesla’s stock. The dividend preferred has been subtracted to eliminate common manipulation through non-recurring items, depreciation, or amortization rate. This presents a better performance of the company.
Source: gurufocus.com
Earnings per share is a critical indicator of the current Tesla share price, and it is important for investors interested in the overall profitability of Tesla. In this case, Tesla is not profitable because of negative values.
Price Earnings Ratio
Tesla is currently losing money and, therefore, the price-earnings ratio is meaningless. That is, Tesla lacks positive earnings and posting losses, making the ratio impractical for decision-making.
Source: gurufocus.com
Gross Margin
Gross Profit / Revenue or Sales
Source: Morningstar.com
This ratio is consistent to show that Tesla is doing relatively well, but is fighting to gain the market share and establish a competitive edge over other auto manufacturers.
The risk level of the stock from the investor’s point of view
Tesla stock is considered as high risk by industry experts (StreetInsider, 2016). The rating is based on the cash flow challenges and negative ratios, making such ratios meaningless to investors (The Street Ratings, 2016).
Further, when the P/E ratio is negative, the value is useless to investors because it cannot be used to determine discount valuation or premium. It only shows that Tesla has negative earnings per share.
Analyses have also established that Tesla is over-priced or trading at a premium relative to other competitors or S&P 500 averages (The Street Ratings, 2016). For instance, Tesla’s price-to-sales ratio is 7.16 relative to peers 1.13. The price-to-book ratio (12.79) also reflects a high premium against competitors or peers (3.74).
Tesla, however, has high sales growth (23.35) relative to its peers (18.99). This ratio suggests that Tesla is rapidly gaining market share.
Given the high-risk rating, investors should also expect high rewards from Tesla. In this case, it is observed that investors have a choice. That is, they can invest in cash-rich regular automakers at low valuations or invest in Tesla because it presents the best chance to alter the industry fundamentals notwithstanding its current spending patterns and a lack of any near-term valuation indicators. Hence, Tesla stock is all about assessment and interpretation of risk and rewards. Thus, Tesla is not for every potential investor (Abramov, Radygin, & Chernova, 2015).
Key strategies to use to minimize these perceived risks
The investor must understand the financial risks and metrics of Tesla. Financial tools, such as ratio analysis, can greatly assist investors in decision-making. For instance, year-over-year ratios can be used to predict future performances albeit to a lesser extent because of other market fundamentals (Kubota & Takehara, 2010; Fathi, Zarei, & Esfahani, 2012).
The investor should also consider other investment options. For instance, a long-term investor may wish to consider corporate bonds because of relatively low risks compared to stock investment. Fixed income instruments can assist the investor to mitigate potential losses that Tesla may yield. Further, there is a need for constant changes or improvements to the investor’s portfolios. Such adjustments should be used to mitigate risks in stocks. That is, the investor will have a fixed risk-return ratio for a given portfolio to account for the long-term growth-oriented investment in Tesla stock. In this case, other long-term value-oriented stocks offered by GM and Ford could be an alternative in the auto industry. Hence, low-risk financial investment is a strategy to mitigate the negative impacts of Tesla.
The investor should also keenly follow the activities of Tesla, and possible reactions of other investors, including market information (Kumar, Dixit, & Francis, 2015; Mollik & Bepari, 2015). The announcement to acquire SolarCity, for instance, has led to a decline in Tesla’s stock price because both companies are loss-making entities. Thus, the acquisition announcement should inform future decisions to buy, hold, or sell (Smit & Moraitis, 2010).
Recommendations of this stock as an investment opportunity
It is recommended that the long-term growth-oriented investor should buy Tesla stock. It is believed that Tesla stock has huge potential to appreciate and generate massive returns once the ambitious targets are attained. The recommendation is based on the following observations.
Growth
Tesla is most likely to grow more than its current position because it is still considered as a startup driving two emerging industries with massive impacts.
Total Return
Based on the historic price movement of the stock, Tesla has gained more percentage than it has lost. Many analysts claim that Tesla stock is overpriced.
Price Volatility
The historical price movement has generally been good. In this case, most investors have often reacted to ‘noise’ rather than major events. Thus, price volatility noted will improve once the company attains some of its targets.
Financial Position
The gross margin has continued to increase year-over-year as Tesla acquires more market share. Nevertheless, the net income declined to affect overall performance. Also, the weak liquidity noted in quick and current ratios are temporary, which will improve. Overall, the liquidity continues to improve, reflecting an improving cash flow.
Therefore, in the long-term, a growth-oriented investor should be patient and accommodate current activities at the company until the end of the decade rather than investing in firms with low returns and share buyback tendencies.
The investor must be able to understand the company’s dynamics and its abilities to disrupt the auto industry and the clean energy division. Tesla has unique abilities to realize its goals.
The bottom line is Tesla stock is recommended for a long-term, growth-oriented investor who can afford to lose some investment portfolio, and this risk has been observed in the latest price decline in the stock. While some investors are selling, Tesla remains a superior buying investment opportunity.
References
Abramov, A., Radygin, A., & Chernova, M. (2015). Long-term Portfolio Investments: New Insight into Return and Risk. Russian Journal of Economics, 1(3), 273–293.
Anderson, K. Tesla Motors Inc (TSLA): A Great Buying Opportunity In The Stock Right Now. ETF Daily News.
D’Allegro, J. (2015). The biggest mutual fund bets on Tesla Motors.
Fathi, S., Zarei, F., & Esfahani, S. S. (2012). Studying the Role of Financial Risk Management on Return on Equity. International Journal of Business and Management, 7(9), 215-221. doi: 10.5539/ijbm.v7n9p215.
Kubota, K., & Takehara, H. (2010). Expected Return, Liquidity Risk, and Contrarian strategy: Evidence from the Tokyo Stock Exchange. Managerial Finance, 36(8), 655 – 679.
Kumar, M. V., Dixit, J., & Francis, B. (2015). The Impact of Prior Stock Market Reactions on Risk Taking in Acquisitions. Strategic Management Journal, 36(13), 2111–2121. doi: 10.1002/smj.2349.
Mollik, A. T., & Bepari, M. K. (2015). Risk-Return Trade-off in Emerging Markets: Evidence from Dhaka Stock Exchange Bangladesh. Australasian Accounting, Business and Finance Journal, 9(1), 71-88.
Mourdoukoutas, P. (2016, April 4). Tesla Is A Great Company, But Is It A Good Investment?Forbes.
Smit, H. T., & Moraitis, T. (2010). Serial Acquisition Options. Long Range Planning, 43, 85-103. doi: 10.1016/j.lrp.2009.10.001.
StreetInsider. (2016). High Risks-High Rewards for Tesla (TSLA) Investors; Morgan Stanley Sees Buying Opportunity.
The Street Ratings. (2016). Tesla Motors, Inc.
Vanguard Group, Inc. (2016). Vanguard Portfolio Allocation Models.
Appendix
Source: Finance.yahoo.com
Ford and GM stocks are better for long-term, value-oriented investors