Tesla is not a Magnificent 7

It appears investors have finally woken up to the reality of electric vehicle (EV) manufacturers; they are just car companies with car company economics. It was always right to question Tesla’s (NASDAQ: TSLA) inclusion in the Magnificent 7. They are a group of companies that only have share price appreciation in common. However, Tesla has always been a bit of an outlier because it lacked one thing the other six have – pricing power. More about that shortly.

Way back in 2021, EV manufacturers were on a tear. An investor who had committed $100 to Tesla shares in January 2020 held an investment worth $750 twelve months later, in January 2021. The same $100 investment in the EV truck maker Nikola (NASDAQ:NKLA) was worth almost $3200, Arcimoto (NASDAQ:FUV) $2000, and BYD $500.

As previously written, EV Specialists significantly outperformed traditional automakers such as Toyota, Ford, BMW, Ferrari, Volvo, and Daimler.

Upon reflection, you might think it’s silly (we did), but the EV manufacturers were trading at multiples of sales that left traditional car makers in the dust. While Toyota was trading at one-time sales, General Motors (NYSE:GM) was at 0.8 times, Ford (NYSE:F) was at 0.5 times sales, Tesla was approaching 50 times sales, BYD was just under 10 times, and NIO was over 50 times.

Is the EV market a fad?

The market's optimistic view on the transition to EVs has led to a significant increase in the perceived value of the industry's future profitability, with this perception more than doubling in the twelve months since March 2020. The optimism was reflected not only in the valuation of EV-specializing companies but also in the rising share prices of raw material producers for EV-relevant metals like copper, lithium, and nickel.

While the market behaviour was puzzling, it was behaviour that is typical of fads.

Mispricing amid hype and exuberance is a repeating reality in markets, and the EV bubble was no different. Despite merely being competitors to legacy automakers, the EV upstarts were collectively being priced as winners. Investors had simply, once again, overlooked the inevitable selection of actual winners and losers.

Back on March 17, 2021, I concluded:

“...changing [propulsion] technology…should not increase the total profit pool of the industry and change the fact that auto manufacturing is a very competitive and capital-intensive industry with generally low margins and returns. I suspect that as we see more of the traditional auto manufacturers launch their EV models, the market’s perception of the future industry profit pool in general, and the prospects for some of the new entrants, will dramatically change.”

Ignoring those concerns, Tesla’s share price hit a high of U.S.$407.00 that year.

The future and reality, however, have now arrived, and investors are finally applying a dose of actuality to their evaluations of the disruptive power of EV upstarts (as distinct from startups!) and vindicating our assessment of their long-term prospects.

Sentiment towards Tesla becomes increasingly cautious

Two weeks ago, for example, scepticism towards Tesla deepened with analysts pointing out the diminishing impact of the electric vehicle giant's price cuts on stimulating demand. A Wells Fargo analyst, Colin Langan, issued a client note expressing concerns over Tesla's slowing growth in key markets, predicting stagnation in Tesla's sales this year and a decline in 2025.

Downgrading the stock to a SELL, Wells Fargo described Tesla as a "growth company with no growth," citing sales growth of just three per cent in the second half of 2023 compared to the first six months, and this despite a five per cent reduction in prices.

The sentiment around Tesla has become increasingly cautious, with the proportion of positive analyst ratings reaching its lowest point.

Deutsche Bank highlighted several factors dampening Tesla's operational efficiency, including a slower increase in model 3 production in the U.S., an earlier-than-planned factory shutdown, and a recent arson incident at Tesla's Berlin plant.

Meanwhile, Adam Jonas, an analyst at Morgan Stanley, has raised concerns about Tesla's profitability, questioning in his March 6 note to clients whether Tesla might face a loss at some point within the year and adjusting the target price for Tesla downwards from $345 to $320, citing the challenges confronting the electric vehicle market.

And it seems Tesla itself is acknowledging reality, admitting in January that its growth prospects for the year would be "notably lower". That realisation is echoed by other companies in the EV orbit, including other automakers, suppliers, and rental car firms, all expressing apprehension about EV demand.

After we warned investors in 2021 that Tesla was just a car company, its share price hit a high of U.S.$407, making us look out of step, if not wrong, but this year, Telsa's shares are down 29 per cent, making it one of the S&P 500s most substantial decliners.

Since its 2021 highs, Tesla shares have been down by almost 60 per cent, removing Tesla from the top 10 companies on the S&P 500. And despite the recent declines, Tesla's stock still boasts a forward earnings valuation of 55 times its earnings, starkly above the Bloomberg Magnificent 7 Price Return Index's average of about 30 times.

Car manufacturing is a thankless task. It’s capital- and labour-intensive manufacturing of fashion items with fashion, models and colours changing almost annually. We have always maintained that as EV startups mature and become fully-fledged car manufacturers, and as incumbents churn out EVs themselves, the economics of the startups will revert to the industry mean.

Despite all the sophistication of our friends at investment banks around the world, that reality is only now sinking in.

Our partner, Polen Capital, who manages the Polen Capital Global Growth Fund, focuses on quality and growth. Understandably, the Fund has never owned Tesla. You can find out more about assessing quality and growth companies and the Polen Capital Global Growth Fund.