The electric car is nothing new. In fact, electric cars were first seen in the 1800's, but the internal combustion engine became so efficient and gasoline so cheap, electric cars quickly lost favour. When the highway system was created in the 1960's, electric vehicles were increasingly viewed as impractical because of their limited driving range.
Since that time, public perception has undergone a drastic change, leading to an evolution of the auto industry. As demand rises for near zero emission vehicles, it's clear that people living in the U.S. aren't content to live in the pollution produced by the combustion engine. Tesla Motors has stepped into the void, providing buyers with the best of both worlds, producing cars that are visually appealing and fast, but also run on a lithium-ion battery.
Skeptics correctly point out that electric vehicles have repeatedly come and gone over the last 120 years and that the auto-manufacturing boom has seen thousands of companies fail. Information provided by the University of Colorado reveals that the U.S. had over 2,000 firms producing automobiles in the early 1900's. Today, only three run the show – Ford Motor, General Motors, and Chrysler. That said, an investment in this industry could be viewed as relatively risky.
Can Tesla be successful? Management is guiding the young company in a pioneering way. Usually when a new car company from Japan or Korea attempts to penetrate the U.S. market, they begin building low-cost cars that appeal to the masses and are easily accessible. Then, as the brand is built, they move into the upscale market by producing cars in the luxury category.
Tesla has turned this approach upside down. The company's first car was a super-fast roadster – sexy, fast, expensive and electric. Now, the company is moving downstream with the introduction of the Tesla Model S, an electric, luxury sedan with zero emissions that won the 2013 Motor Trend Car of the Year and Automobile Magazine's 2013 Automobile of the Year. According to Consumer Reports, the Model S was ranked as a near-perfect car, naming it the best car it has ever tested. Note, it didn't rank as the best electric car. Rather, it was named the best car at any price, period. Tesla is on a clear path – driven to produce high quality vehicles and determined to change the Americans' perception of electric cars.
So, is the company itself a good investment, or would it make more sense to invest in its component makers? To a person who isn't trained in the automotive industry, the components of this car seem unremarkable, with the exception of the lithium-ion battery. However, it's virtually impossible to invest in battery makers. They are either tiny parts of giant companies, or tiny companies on their own, neither of which are attractive investments.
Tesla just turned their first quarterly profit, which is not only a major milestone, but also important to answering the question of whether or not Tesla is a solid investment. A company that is only recently profitable is not going to have very attractive financial ratios, which are typically based on four quarters of data and Tesla's financial ratios are expensive. Currently, the stock trades in the area of 11x sales and 62x book value. It's difficult to find stocks that trade with ratios that high.
At this time, an investment would be considered fairly aggressive and speculative. However, many fast growth, disruptive technology companies have financial ratios that are out of the norm during the early years.
Tesla will face many challenges, not the least of which is the auto industry's propensity to be highly capital intensive. Also, it's entirely possible that history will repeat itself and the electric car could once again be pushed under the rug as gasoline prices drop. New sources of oil based on fracking in various regions of the U.S. are dramatically increasing the supply of oil and suppressing prices. Fracking is not only creating new sources of oil in the U.S., but overseas as well. Australia has discovered a harvestable oil field that is roughly equal in oil reserves to Saudi Arabia. World oil prices will not go up unless the global economy kicks into faster gear.
When investing, it seems a bit arrogant to create a position in a stock based on one's own opinion on electrics, global warming, etc. The best thing to do in the case of Tesla is to take a small position and watch it slowly grow, while keeping an eye out for competition. Also, if you buy a position now, you will be in good company. Tesla's CEO, Elon Musk recently announced that he would buy $100-million of the company's stock as part of a secondary offering, which was completed less than two weeks ago. Secondary offerings often sink a stock's value, but this wasn't the case with Tesla. As of today, shares of Tesla are up nearly 5 per cent.
An example of starting small with a disruptor would be Intuitive Surgical. As soon as we learned about this company in 2005, we began investing at a price of only about $25 a share. Today it trades around $500 a share. A groundbreaking technology like robotic surgery can be risky, so we started small. But by sticking with it, the profits have risen to a massive 1,700 per cent or more. By wading in with a small investment, you won't be tempted to dump the stock whenever it hits a bump in the road because your overall exposure will be relatively insignificant.
Tesla hit one of these investment bumps when they first announced its secondary offering. However, the offering enabled the company to keep its promise of paying back $465-million to the U.S. Department of Energy early. Tesla received the loan in January 2010, agreeing to a 10-year repayment program, but used the proceeds from the secondary offering to pay off the loan in full just three years later.
If the momentum of the electric car movement continues to build, a company like Tesla that produces luxury products combined with cutting edge technology is poised to be on top.
Disclaimer: Warren Financial has no position currently in Tesla but is considering going long.