Tesla (NASDAQ: TSLA) has already disrupted the auto world once. Against heavy odds and plenty of skepticism, the company proved that an electric vehicle (EV) manufacturer can be viable and profitable.
It first turned a profit in 2020, the same year that the stock soared to new heights as investors recognized that EVs were now the future of the auto industry.
Tesla's stock price has remained elevated but volatile since then, even as the company's revenue growth has slowed significantly and its profits are now declining as it has cut prices to stay ahead in an increasingly competitive EV market.
These days, the company is far from the only option in EVs as it competes with start-ups like Rivian, Lucid, and Fisker, and legacy automakers that are ramping up EV production, like GM, Ford, Hyundai, and Nissan.
Even as Tesla's revenue growth has slowed, coming in at 9% in the third quarter, its valuation has remained lofty. The stock currently trades at a price-to-earnings (P/E) ratio of 75. That is many times more expensive than its legacy peers like GM and Ford, which are trading at earnings multiples in the single digits. Even Toyota, the world's biggest carmaker by number of units, is valued at a P/E of just 10.
Part of Tesla's premium is attributable to its future products and expected growth in production. The company is set to start delivering its Cybertruck at the end of November, and the discount-priced Model 2 is expected to be unveiled soon.
It's also opening a factory in Mexico, though CEO Elon Musk said it is moving slowly with it due to the economy. Higher interest rates have weighed on demand from car buyers.
Beyond the expected increase in production and new vehicle models, there's another reason the stock is valued at a premium. Many investors expect the company to disrupt the auto industry through automation and artificial intelligence (AI).
What is the AI of Tesla?
Cathie Wood's Ark Invest has long counted Tesla among its biggest holdings, and the central component of her bull thesis is that Tesla will be the leader in an estimated $9 trillion robotaxi market by 2030. Wood's company expects robotaxis to make up 64% of its earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2027, compared to just 29% from EVs, and Ark has a price target of $2,000 a share on Tesla in 2027.
AI also seems to be the aspect of the business that Musk is most excited about. On the recent earnings call, he touted the company's full self-driving (FSD) version 12, and said AI was a "massive game changer." He also said that success in AI has the "potential to make Tesla the most valuable company in the world by far."
In addition to full self-driving and robotaxis, the company is also building out its Optimus autonomous robot and its Dojo supercomputer. Musk said the company was making progress with the Optimus robot, and he believes Dojo, which is helping to train its FSD software, could provide a competitive advantage as well.
Will AI pay off big for Tesla?
Investors are willing to pay a premium for Tesla shares right now because the company has already proved it's a successful innovator, and Musk, though erratic, is regarded as a visionary CEO, capable of launching transformative technologies.
For investors at this point, assuming that Tesla will lead the AI revolution in autonomous vehicles and beyond seems a little bit like a leap of faith. Self-driving cars have faced significant regulatory hurdles in their quest to take over the road. GM's Cruise project was just pulled off of San Francisco's streets, leading to the departure of Cruise CEO Kyle Vogt, and regulators have appeared unwilling to tolerate accidents caused by autonomous vehicles.
Tesla's autonomous driving system remains in beta testing, and it's yet to operate vehicles on a public road without a driver behind the wheel. The company also has a long history of product delays, adding to skepticism that a launch of its robotaxi will happen when promised.
With a market cap of around $750 billion, the stock would also appear to have more of a limited upside compared to where it was before it took off in 2020.
Still, investors are likely to give Tesla the benefit of the doubt in AI until proved otherwise, especially as long as Musk is making statements that it could be the most valuable company in the world by far. That means that Tesla could hold most of its value for the foreseeable future, even as the EV business is challenged.
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