tesla stock
espite extensive literature on the subject, the question of whether and how market sentiment affects stock prices remains an
interesting and unresolved question.1 Following DeLong et al. [1990], we define
investor sentiment as a belief about future
cash flows and investment risks that is not
justified by the facts at hand. In this article,
we extend that literature by examining one
particular event in detail. That event is an
almost sevenfold increase in the price of Tesla
in less than one year. On March 22, 2013,
Tesla was trading at $36.62. By February 26,
2014, the price had risen 590.9%, to $253.00.
(Tesla does not pay a dividend, so the price
path reflects the total return on the stock.) In
comparison, the total return on the S&P 500
Index during the same interval was a much
more modest 20.4%, so that the total net of
market return over the period for Tesla was
471.1%. An equally weighted index of the
other major automotive manufacturers listed
on American exchanges closely matched the
overall market during the interval, rising
16.2%, so Tesla’s jump clearly was not
industry-related.2
tesla stock
Exhibit 1 plots the paths of wealth for
Tesla, the aforementioned index, and the S&P
500 from the date of Tesla’s IPO to the end
of the run-up period. What makes Exhibit 1
particularly surprising is that, for the first two
and a half years following Tesla’s IPO in June
2010, Tesla’s price tracked both the market
and the industry indices. Then, beginning
on March 22, 2013, the two paths diverged
dramatically. This article studies that sudden
shift and the subsequent dramatic run-up. In
particular, we attempt to isolate the possible
role played by market sentiment.
Of course, large increases in the price
of individual stocks, though rare, are hardly
unprecedented. However, Tesla is special
along a variety of dimensions that make
it a uniquely useful test case for studying
whether market sentiment played a role in
the run-up.
tesla stock
First, Tesla is part of large, mature, and
well-defined industry. By 2012, the manufacturing of automobiles had matured to the
point where the long-run growth rate of the
industry closely mirrored long-run aggregate
growth. This is helpful, because much of the
debate regarding the role of sentiment during
the internet boom of the 1990s, and to an
extent during the current social media boom,
is over the extent to which sharp run-ups
in prices can be attributed to rational assessment of industry growth. Because forecasting
growth rates for newly developing industries, such as social media, typically requires
making assumptions that are hard to verify
on the basis of historical data, unambiguous
conclusions are difficult to draw.
Second, the mature state of the industry
also makes it easy to identify comparable
companies. This is helpful, because comparable company
analysis is a useful tool in valuation analysis. In addition,
the slow, predictable growth of the aggregate market
implies that a sudden, dramatic change in the value of
Tesla stock means that Tesla must be expected to profit
at the expense of competitors, so it is important to be
able to identify those competitors unambiguously.
Third, the available technologies in the industry
are largely known, and innovations are incremental.
There is not the “Twitter” problem, where much of the
value of a company is attributable to growth options
related to some as-of-yet unspecified technology. Even
Tesla, trumpeted as an innovator in the automotive
industry, uses electric motor technology that has been
widely available for years and relies on established battery technology and batteries provided by third-party
suppliers.
tesla stock
Fourth, the stable nature of the business implies
that the expected return, whichever model is used to
estimate it, should not be changing rapidly. Therefore,
when investigating the sudden divergence of the stock
price from movements in the market and the industry, it
is not necessary to waste time worrying about whether
the changes are due to variation in the discount rate.
Fifth, the run-up in the price of Tesla occurred
over almost a year. Therefore, it cannot be related to the
market learning of a few pieces of previously undisclosed
information. It must reflect an ongoing reassessment of
the company’s long-term prospects, though not necessarily a rational one.
Finally, there is the added bonus that one of us,
Damodaran [2013a, 2014], developed detailed discounted
cash flow models for Tesla in real time and posted the
results online on September 4, 2013 and March 25, 2014.
As later discussed in detail, he calibrated the models
using what we believe to be optimistic assumptions
regarding Tesla’s future growth and operating margins.
Nonetheless, the estimated values for Tesla were $72.00
in September 2013 and $100.31 in March 2014. In both
cases, this is only about 40% of the market price.
We also employ standard analytical tools, including
an event study and an examination of the holdings
(including shorts) of Tesla stock, to supplement our
valuation analysis. Here, too, we find evidence that the
run-up cannot be attributed to a rational evaluation of
fundamental news.
TESLA: A BRIEF HISTORY
Tesla Motors (Tesla), incorporated on July 1, 2003,
designs, develops, manufactures, and sells electric vehicles
and advanced electric vehicle powertrain components.
The company is also involved in designing, developing,
and manufacturing lithium-ion battery packs, electric
motors, gearboxes, and components both for its vehicles
and for its original equipment-manufacturer customers.
Tesla owns its sales and service network. The company
went public on June 29, 2010.
Tesla’s first car, the Tesla Roadster, a high-performance electric sports car, was a moderate success. On
June 12, 2012, Tesla began deliveries of its Model S, a
four-door, five-passenger premium sedan. The reviews
of the car were highly favorable and it was well received
by customers.
tesla stock
Currently, Tesla manufactures cars at its factory in
Fremont, California. The company also has an electric
powertrain manufacturing facility in Palo Alto, California. In addition to building cars, the company provides services for the development of electric powertrain
components and sells electric powertrain components to
other automotive manufacturers.
PRICING VERSUS VALUATION:
CONVERGENCE AND DIVERGENCE
Though the words “price” and “value” are often
used interchangeably, here they mean different things.
When we use the term “value” in this article, we mean
our estimate of value. Price, on the other hand, is determined by supply and demand in the marketplace. That
supply and demand may depend on factors other than
rational estimates of future cash flow.
Rather than rehashing old debates about price and
value, we use Tesla’s evolution as a case study of how
both value and price evolve in the market. The analysis
proceeds in three steps. First, we develop DCF models
to estimate the value of Tesla under what we consider
to be a set of aggressively optimistic assumptions. Next,
we compare those estimates to the market price of the
stock and find, as noted earlier, that the stock appears
to be dramatically overpriced. In step three, we study
the stock’s trading behavior, both in terms of how it
responded to information and in terms of changes in
institutional holdings and short sales. We find further
evidence consistent with that from the valuation analysis—the sharp run-up in Tesla stock far exceeds that
which can be explained by fundamentals.
THE DCF VALUATION MODELS FOR TESLA
The approach we use is that described by Damodaran [2013b]. This approach focuses on four basic
inputs. The first input is the expected cash flow from
existing assets. The second input is expected growth,
with growth in operating income being the key input.
Because this growth requires investment, the value effect
of growth depends on how efficiently that growth is
generated, in terms of required investment. The third
input is the discount rate, defined as the cost of the firm’s
overall capital, when valuing the business, and as the cost
of equity, when valuing equity. Other things remaining
equal, companies that operate in riskier businesses or
countries should have higher costs of equity and capital than companies in stable businesses and developed
markets. The final input is the terminal value, defined
as the firm’s estimated value at the end of the forecast
period. This estimate is generally based on the assumption that cash flows will grow at a constant rate forever
beyond that point, which in turn requires the firm to
be mature and grow at a rate less than overall economic
growth. In Tesla’s case, this requires a long forecast
horizon, because we anticipate a substantial period of
supernormal growth.
The Challenge of Young Companies
Looking at the four inputs highlights the problems that analysts face in valuing young companies such
as Tesla. The cash flows from existing assets are often
negative, with operating cash flows being nonexistent
or small (because the firm’s revenues are small) and
investing cash flows being large (as the company ramps
up for growth). As a result, almost all of the company’s
value comes from future growth, but the crutches used
to estimate that growth, including past growth or sustainable growth models, are missing.
In an earlier article, Damodaran [2013b] laid out a
three-step process to deal with the estimation challenges
raised by young companies. The first step is estimating a
revenue growth rate. That estimate, in turn, is driven by
an estimate of the growth of the overall market in which
the company operates, in conjunction with an evaluation
of the relative strengths and weaknesses of the company’s
products and services. The second step is forecasting a
target operating margin to which the company’s margin
will converge over time. That forecast is typically based
on the margins earned by the industry’s most comparable
mature companies. The final input is an estimate of the
investment required to achieve the forecast growth; this
is typically derived by examining changes in revenue
from period to period and making judgments on how
much additional capital will be required to provide for
growth.
The discount rate in the valuation (cost of capital)
is best estimated by looking at publicly traded companies
in the same space as the young company, with the initial estimates tied to smaller, riskier firms in the sector
and the end numbers reflecting larger, more mature
firms. Although incorporating risk into discount rates
is important, it is also important that we remember two
other factors. The first is that a significant portion of
the risk to which young firms are exposed is company
specific, and should be diversifiable at a portfolio level.
The second is that young firms have a greater chance of
failure than more mature firms, but that survival risk is
ill suited for inclusion in the discount rate, and is better
considered explicitly when valuing the firm. This is
because the cash flows to be discounted are expected
cash flows, not anticipated cash flows that are conditional on the company surviving. To take account of
this distinction, we introduce an estimated probability
of failure, using the expected proceeds in the event of
failure (usually liquidation proceeds) to compute an
expected value.
Tesla’s Historical Performance
Though Tesla’s history is short, the starting point
for assessing future revenue growth is its past track record.
Exhibit 2 plots Tesla’s quarterly revenues, from inception
through the end of 2013. The exhibit shows relatively
flat revenue until the introduction of the Model S. That
led to a burst of growth that then flattens out.
Tesla’s profits have followed a rockier path, with
losses accumulating over time. Although the extent of
the losses depends on the choice of measure, for much
of Tesla’s history, every measure of profitability has been