Tesla Motors’ visionary management offers lesson in long-term growth

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Chris Umiastowski is the growth investor for Strategy Lab. Globe Unlimited subscribers can read more in the series at tgam.ca/strategy-lab.

Almost three years ago, I added shares of Tesla Motors to my Strategy Lab model growth portfolio. The price per share has grown nicely from about $120 (U.S.) back then to about $200 today, making for an impressive return on investment. It has also been fascinating to follow the wild ride. Tesla stock, just like a Tesla electric car, is exciting. If you are going to pick your own stocks, you may as well pick stocks that are personally interesting so you remain well-informed.

When I first looked at Tesla stock in 2013, I saw a path to profitability within one year because the company had a solid plan to improve gross margin on vehicle sales. It did achieve great improvement in gross margin and sales growth. But that growth came along with rapidly increasing operating expenses and higher losses. Shouldn't I have sold the stock by now?

Not so fast. While I thought it would make money sooner, that short-term expectation was not at all central to my investment thesis. Instead, I was looking forward to seeing enormous growth in vehicle sales, expansion of global operations and the launch of a lower-cost electric sedan, which we now know to be the Tesla Model 3, expected to enter production next year.

Anyone paying attention to the stock probably knows Tesla posted a profit in its third-quarter results last week. And it may post a fourth-quarter profit too, but the profits are small and will probably vanish in 2017 as the ambitious growth plans continue.

When it comes to growth stocks in emerging markets, I have noticed that visionary management teams tend to come up with all kinds of wild ideas I had never considered. That works for me. Elon Musk is a visionary CEO. I am not.

While I did expect Mr. Musk to focus on vehicle production growth at Tesla, and he has, I did not expect several of his other major moves.

I have been positively surprised by how the Tesla story has expanded well beyond my line of sight back in 2013.

Here are three examples:

• Tesla is rapidly constructing the world’s biggest battery factory in the Nevada desert. When completed, the Gigafactory is expected to reduce the price of batteries used in Tesla vehicles significantly. In 2013, I never saw this coming. Yet in retrospect I don’t know how else they could possibly scale above half a million cars a year.
• Tesla launched an entirely new energy business. The company is now busy designing and selling battery-storage systems for homes, businesses and utilities. Solar energy, in which Tesla is also investing, plus battery storage have the potential to disrupt the energy grid in a way similar to how cellular technology disrupted landline telephones.
• Tesla is determined to be the world leader in self-driving cars. When I considered investing in the stock, this was was not part of the story and, if asked about it, I would have guessed it was at least 10 to 20 years away. Today, Tesla is building the hardware it believes is necessary for full self-driving into every car it makes. No other car company is doing this. The software is not ready yet, but as these features become market-ready, Tesla can wirelessly update the fleet. This is an enormous topic, and one that fascinates me with respect to the potential.

I see articles written about Tesla in the financial media every day. Most observers are obsessed with short-term profitability, which I see as leading to crucial investing mistakes. When capital is available and the return on investment looks good, it makes sense to invest. That is what Tesla is doing. Tesla could have taken a more conventional growth track. Mr. Musk could have slowed the pace of factory expansion. He could have chosen not to get into the battery manufacturing business alongside Panasonic.

The company could have taken a slower approach to building sales and service centres around the world. Tesla could have stayed out of the energy-storage business and delayed working on self-driving cars until some other auto company proved the technology first.

Had Tesla taken that alternative road, I bet the company would be posting regular, healthy profits now. But if you believe in the value of what Tesla is doing, it makes mathematical investing sense to expect Tesla to put off profit today for a much bigger profit tomorrow.

I wonder what else Mr. Musk has up his sleeve that will surprise me in the next three years.

Disclosure: The author also owns Tesla shares personally.