While I’m sure Elon Musk has no intentions of selling his stake in Tesla anytime soon, the electric car giant has been exhibiting exceptional value growth with the share price rising over 600% in the last year. With a current market cap of almost $500 billion, some investors already have their eyes on Tesla becoming a trillion dollar company - a very exclusive club reserved for the likes of Apple and Amazon. How that could be achieved is discussed below.
Most owner managed trading businesses can be valued on a multiple of underlying and maintainable profits. Listed entities such as Tesla are often considered on a similar basis - known as the price-earnings ratio (“P/E Ratio”), representing the ratio of a company’s share price to the earnings per share.
Tesla is currently trading at a staggering P/E ratio of c. 900x (based on the trailing twelve month period) which indicates investors are already pricing in substantial growth, particularly when you consider that Tesla has until recently been loss making. Tesla made $331 million of profit in Q3 of 2020, the fifth consecutive profit making quarter. If profits were sustained at that level, it would equate to $1.3 billion of annual profit, and based on the current share price, a P/E ratio of c.370x. For context, Apple trades at a P/E ratio of 35x and Amazon at 100x (after demonstrating revenue growth of 25% per annum), still indicating huge growth is expected for Tesla at the current share price.
Tesla is at an exciting stage: quickly increasing
manufacturing capacity by adding new factories, increasing its product range
with new models, and taking advantage of the large size of the automotive
marketplace without a clear direct competitor. Tesla produced 145,000 units in
Q3 of 2020 which is over 50% greater than Q3 of 2019! All of these factors
point to Tesla increasing profits through growth, but also driving up the
profit margin as manufacturing processes are automated, further economies of
scale are achieved, and battery costs are reduced.
Naturally, as Tesla grows its profits, the P/E Ratio will reduce as growth is already incorporated in the current share valuation. However, if Tesla can settle down to a 50x P/E ratio on earnings of $20 billion, which some commentators predict could potentially happen by 2025, Tesla may end up being a trillion dollar company.
Stepping back to reality from the impressive numbers
quoted above, small owner managed businesses are often valued based on a single
digit profit multiple. However, if revenue and profit levels can be grown,
revenue quality improved, and a management team implemented to avoid any
succession issues with your departure, the multiple can be increased. Pair that
with a higher profit figure, potentially based partly on forecast earnings, and
the valuation soon rises.
Actual growth and projected growth will not only add value but also improve marketability, especially if the growth trend is at a demonstrable rate supported by a solid business plan and robust forecast information. Private equity buyers will particularly be interested in this, looking to make gains through injecting capital to maximise growth. Preparing your business in the months and years before a sales process can significantly increase both the marketability and value achieved.