This week, I use AAII’s A+ Stock Grades to give you insights into a popular technology stock that has a huge investor following and is the newest member of the S&P 500 index: Tesla Inc. (TSLA).
Electric Vehicle Cult Stock’s Entry Into the S&P 500
This week marked the first trading day for Tesla as a component of the S&P 500. Last Friday saw a big jump in the electric carmaker’s shares, as index funds that track the S&P 500 began preparing to purchase billions of dollars’ worth of Tesla stock to match their holdings with the large-cap index. It was the largest rebalancing in the history of the S&P 500.
According to the Associated Press, in the middle of last year, Tesla’s losses were piling up, sales weren’t enough to cover expenses and big debt payments loomed. The situation was so bad that one influential Wall Street analyst raised the possibility that Tesla wouldn’t be able to pay its bills and would have to be restructured. Since then, even after a recent pullback, the electric car and solar panel company’s shares have skyrocketed, up more than 675% year to date.
An enthusiastic investor base has helped boost Tesla higher and higher in recent months, even though the relentless rise sometimes defies fundamental metrics. Many analysts warn that Tesla shares are vulnerable to a pullback following their nearly sevenfold increase this year, mostly since the company has not posted similarly strong financial results. Tesla is the most heavily shorted stock in the world with more than $34 billion in short interest. That amount of short interest is three times more than the second most shorted stock, Apple Inc. (AAPL). Short sellers have been taking a thumping all year.
Tesla’s rise to become the world’s most valuable automaker and ranking among the top 10 largest U.S. companies in the S&P 500 is a remarkable achievement considering that the company lost $1.1 billion in the first half of 2019. The increase was so spectacular that even CEO Elon Musk has said the shares are overpriced.
Tesla’s market cap has grown to be nearly the size of the entire legacy auto market, despite the fact that Tesla represents only a small fraction of global auto sales. Based on Monday’s market close, Tesla is worth more than Toyota, Volkswagen, General Motors, Ford, Fiat Chrysler, Nissan and Daimler combined.
Tesla’s Potential to Change the World
Tesla designs, develops, manufactures and sells high-performance fully electric vehicles and components, as well as a full suite of renewable energy products, including solar, storage and grid services. Tesla sells and services its vehicles through a company-owned network in North America, Europe and Asia.
Tesla reported that it produced over 145,000 vehicles and delivered nearly 140,000 vehicles during the third quarter, up 51% and 44% year over year, respectively. Tesla expects to deliver 500,000 vehicles this year driven by the Model Y, an electric crossover utility vehicle, and continued strong demand in China.
Tesla has the potential to “change the world” with long-range electric vehicle technology, autonomous driving technology and battery technology that can store the solar energy its products generate. However, mass adoption of electric vehicles by consumers could be many more years away than the company expects. Some of the key risks facing Tesla include government regulation of autonomous driving and potential capital raises. Tesla is also entering a major capital expenditure cycle with the construction of new factories in Texas and Germany, which could weigh on near-term free cash flow.
Grading Tesla With AAII’s A+ Stock Grades
When analyzing a company, it is useful to have an objective framework that allows you to compare companies in the same way. This is one reason why AAII created the A+ Stock Grades, which evaluate companies across five factors that have been shown to identify market-beating stocks in the long run: value, growth, momentum, earnings estimate revisions (and surprises) and quality. Using AAII’s A+ Stock Grades, let’s evaluate how attractive Tesla is based on its fundamentals.
The following table summarizes the stock grades for Tesla, an electric vehicle and renewable energy company.
Tesla’s Growth Grade
Tesla has a strong A+ Growth Grade of B. The Growth Grade considers both the near- and longer-term historical growth in revenue, earnings per share and operating cash flow.
By and large, Tesla has exhibited solid growth in its latest fiscal quarter and over the past five years. While sales dropped 49% year over year for the quarter ending September 30, 2020, the company managed to boost earnings by 125% and operating cash by 145%. All this data is available on the Grades tab of a stock’s A+ Stock Evaluator page. While not part of the Growth Grade, Tesla has managed triple-digit year-over-year earnings growth for each of the last three quarters.
While the company has been posting impressive quarterly growth, long-term earnings growth has been elusive for Tesla thus far, as it has contracted by an average of 15.6% a year over the past five years. However, sales have been growing by 50.4% a year, while cash from operations has been expanding by 113% a year over the past five years. Also, the company has seen earnings growth for its last two fiscal years, although this is not part of the Growth Grade calculation.
Tesla’s Quality Grade
A higher-quality stock possesses traits associated with upside potential and reduced downside risk. Backtesting of the Quality Grade shows that stocks with higher Quality Grades, on average, outperformed stocks with lower grades over the period from 1998 through 2019.
The Quality Grade is the percentile rank of the average of the percentile ranks of return on assets (ROA), return on invested capital (ROIC), gross profit to assets, buyback yield, change in total liabilities to assets, accruals, Z double prime bankruptcy risk (Z) and F-Score. The score is variable, meaning it can consider all eight measures or, should any of the eight measures not be valid, the valid remaining measures. To be assigned a Quality Score, though, stocks must have a valid (non-null) measure and corresponding ranking for at least four of the eight quality measures.
Tesla has a Quality Grade of C, putting it in the middle among all U.S.-listed stocks.
The company ranks poorly in terms of its return on invested capital, ranking in the 17th percentile of all U.S.-listed stocks, and in terms of buyback yield (the percentage change in the number of shares outstanding over the last year), ranking in the 27th percentile.
Tesla does rate well when it comes to its F-Score, a composite score of various fundamental factors used to evaluate a company’s overall financial strength. Tesla has an F-Score of 7 out of 9, which ranks in the 89th percentile.
Tesla’s Value Grade
Successful stock investing involves buying low and selling high, so stock valuation is an important consideration for stock selection.
Buying stocks that are going to go up typically means buying stocks that are undervalued in the first place, although momentum investors may argue that point.
With its stock up over 675% for the year, Tesla has a Value Grade of F, based on its score of 97, which is considered ultra-expensive. The company’s Value Score ranking is consistent across several traditional valuation metrics, with a score of 92 for the price-to-sales ratio, 95 for the price-to-free-cash-flow ratio and 97 for the price-to-book-value ratio (remember, the lower the score the better for value).
The Value Grade is the percentile rank of the average of the percentile ranks of the valuation metrics mentioned above along with the price-earnings ratio, enterprise-value-to-EBITDA (EV/EBITDA) ratio and shareholder yield.
In the A+ Investor database, Tesla does not have a price-earnings ratio. The company does have positive GAAP earnings over the trailing 12 months of $0.51 per share, which translates into a price-earnings ratio of 1,286.8 based on Monday’s closing price of $649.86. Based on Tesla’s Value Grade of F, value investors may take pause.
The Choice Is Yours
Whether Tesla fits in your portfolio is a personal decision. Are you a growth- or value-oriented investor? What is your time horizon? What is your risk tolerance? Answering these questions will also help you answer whether Tesla is a good investment.
The stocks meeting the criteria of the approach do not represent a “recommended” or “buy” list. It is important to perform due diligence.
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