More times than not, companies tout statistics other than net profits because the actual profits aren’t that good. Tesla (TSLA) is one such company that falls into this category. Today, Tesla emphasized that it is earning $0.71 per share in non-GAAP earnings. The reason they want to do that is because it makes the valuation of the stock sound slightly less insane. If they can make you think of Tesla as a company with earnings power of $2.84 per share in relation to its stock price of $200 per share, then the valuation of 70x earnings seems like something that can be justified after a couple years of 25% profit growth that matches revenue growth.
In Tesla’s case, the problem with citing non-GAAP earnings is that it ignores some upfront capital allocations associated with building the Gigafactory and the issuance of 15 million shares of Tesla stock that means each share of Tesla (TSLA) stock will own 6% less than it did at the start of 2016.
On A GAAP basis, Tesla only earned $0.14 per share in this past quarter. It is expected to lose $5 per share this year, or somewhere between $900 million and a billion dollars. A modestly profitable quarter does not offset the $600 million lost in the first half of the year. The “truth” at Tesla is that it is issuing lots of stock to executives and is still losing lots of money over the course of the year so it cites things like non-GAAP earnings to make its valuation seem more palatable.
The big picture issue is that Tesla is only expected to make $4 per share in profits five years from now. If that happens, and the stock trades at 35x earnings, the stock’s fair value would be $140 per share. Even if you boost those figures upward for the sake of crafting a best case scenario and imagine $6 per share in profits and a valuation of 45x earnings, we only get a value of $270 per share. That is only 6% compounding if unrealistic projections prove true. The “realistic” case scenario calls for losses of 6% annualized through 2021.
That is why, in September 2015, I wrote “Tesla Investors Await A Rude Awakening.” Back then, I said:
“Tesla traded at $15 per share in 2010. Now, it is at $250. People point to the 35% annual revenue growth to justify the valuation. The problem is that the revenues have been able to grow because Tesla is taking losses on every car it makes. It has actually been the beneficiary of a recovering economy for almost the entirety of its publicly traded life, and the company still hasn’t been able to turn a profit. What will happen during a deep recession when the pool of available customers shrink?”
Fast forward a year, and Tesla has come down 20% in stock price. That drop was justified. The story at Tesla hasn’t changed. In 2021, the stock price is going to be worth somewhere between $140 and $270 per share. That best case scenario only gives you the possibility of mid single digit returns—about what you could get from investing in a utility index! However, the downside is much worse, as investors could lose about a third of their starting capital over a five-year time frame.
Successful long-term investing involves paying a reasonable price for a stream of profits that have a high likelihood of being expected to grow. Tesla may very well pass the second portion of that over the next five years. But it so thoroughly flunks the “reasonable price” requirement that five-year losses are likely and mid single digit returns represent the best case scenario. Some fashionable companies like Alphabet back up their coolness with profits that justify high valuations; Tesla at over $200 per share isn’t one such example.