Why Tesla stock is not risky?

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Author: Yunfei Ma

Editor: Haibo Gao, Siwei Yang, Alan Chen

This article is not investment advice, the author and the editors are all investors in Tesla stock.

When I was an undergraduate student at UIUC, I had a fierce argument with an Economics professor about the future and valuation of Tesla, Inc. That was back in the second semester of my freshman year in 2019 when Tesla was still a company rumored to be bankrupt very soon at a $30 billion valuation. Three years later, as Tesla achieved $1 trillion in market capitalization to be the fifth-largest company in the US, a similar scenario happened to one of my best friends at another university, where his Finance professor was talking about Tesla being risky and overvalued. This has bothered me for quite some time. While these well-respected professors and experts have much more experience and insights talking about public companies and financial systems compared to me, a freshman in math major who did not have any structural knowledge and terminologies to even feel confident commenting on investing in the stock market, why are these professors consistently wrong on Tesla? I am curious to find the answer.

In retrospect, since the year I invested heavily in Tesla, not only some university professors but also well-known fund managers, such as Jim Chanos and David Einhorn, who have achieved great success in the past were betting against Tesla. To find out why the thesis around Tesla as a business has been so polarized, I watched almost all Tesla bears’ arguments in the past years on CNBC and personally encountered many people who are very suspicious of Tesla’s future to even beat other legacy auto Original Equipment Manufacturers(OEMs), I found that the Tesla bear case to be these two aspects: 1) High Valuation and 2) High Risk. For the arguments against overvaluation, it is worth a separate article analyzing thoroughly why Tesla is still extremely undervalued with over a $1 trillion valuation. For the discussion of risk, there are risks in investment strategy and risks in the stock itself. In this article, we only focus on finding out if Tesla Stock is risky. In other words, can we ask the ultimate question, what defines the term “risk” regarding a stock?

For everybody to take a step back and understand how to manage risk in investing, I think we should approach it by understanding 1) what risky stock is and 2) what a risky strategy is. I tried to convince people that Tesla is not risky stock because of how amazing the underlining business is operated as I track the company activities in a daily routine and as a customer myself. I tried to find a way to explain that the fluctuation in stock price short-term is not an indication of the risk in the business itself, but I have not found an elegant way to articulate my thoughts until I found the tweet by Brett Winton. (You can click to view the full thread)

“The risk is not an intrinsic property of the asset, instead, it is a risk at the investment decision-maker level (that they will sell at the worst possible time or buy at the worst possible time.)”

This quote explains exactly why people misunderstood “risk” for so long. The reason why many people unconsciously put Tesla into the category of risky stock is because of the volatility of its stock price and currently high valuation. By the same analysis standards, it will put Ford and General Motors(GM) stocks as safe investments due to less stock price fluctuation and reasonable/low valuation. However, if investing is simply looking at some numbers, ranking the valuation, price volatility, and other metrics to find the best stock with the least risk, everyone will ace it. A stock is not a group of metrics. Only the underlying business matters and everything else is just a recommendation. Of course, from a price volatility perspective, Tesla is much more volatile compared to Ford, GM, and most of the stocks in the S&P 500. Nevertheless, when looking at the underlying business, it is so obvious that Tesla is executing and winning in every aspect of the car market with unlimited demand, resistance to global supply chain problems, the development of the world’s best real-world AI technology, and a once-in-a-lifetime leader Elon Musk. Although Tesla is only producing a fraction of cars compared to established traditional auto OEMs, their business trajectories are totally different. Ford and GM combined have over $270 Billion in debt while Tesla has only around $6 Billion, not to mention its aggressive investments while building two new giga-factories in Taxes and Berlin. It is quite obvious that Ford and GM are struggling to compete with Tesla on a product level and are much more risky businesses with the possibility of bankruptcy long-term-wise.

The actual risk in investment is from the people themselves, especially those who do not have a long-term thinking framework. In this era of technology, if the only focus is the current business and current valuation, one would miss the opportunity of Apple, Amazon, Facebook, Netflix, and Tesla. In the high growth stage of these technology companies, the current valuation can’t justify its current business profits. While these people are looking at these high-growth innovative stocks and calling them risky, they put themselves into a risky dilemma because they invest without even studying the fundamental businesses. Tesla could have been profitable in 2010 if they only wanted to be a sports car company and sell powertrain to Daimler and Toyota, just like Amazon could have only sold books and become very profitable many, many years ago. Big visions require investments, time, and consistent growth. The process of evaluating an investment is not simply to look at the current state of the business or its high valuation, walk away and call it risky. The steps I use to evaluate these growing innovative companies are 1) looking at the fundamental business without thinking about the valuation and stock price to determine if it is a bad or a good business and 2) running the numbers to see how in many years, the earnings could justify the current valuation in different scenarios and whether the time fits my investment horizon. This does not mean all high valuation, high growth companies are good investments. For example, Rivian went public and traded at one time a valuation of over $100 Billion with basically no revenue. The fundamental business still struggling to figure out how to mass-produce electric cars. Therefore, the business is considered “risky” because there are many uncertainties regarding if the management can figure out the solution of mass production of cars. In addition, it is very hard to justify a $100 Billion valuation in 5 years even assuming Rivian will be executing very well. To sum up based on the previous examples, a long-term thinking mindset will always make people focus on the real risk of the fundamental business, while a short-term thinking mindset increases the risk as people ignore good business fundamentals and pour their money into dangerous stocks with seemingly low valuation and stable stock prices.

The capital market determines the valuation and fluctuation of stock, not the business itself. The underlying business can have no correlation with the stock price for quite some time. There is a famous quote many people know:

“In the short run, the stock market is a voting machine. Yet, in the long run, it is a weighing machine.”

Speaking of Tesla, in the years of 2016-2019 before the stock explodes, the stock price was highly manipulated by hedge-funds. The business grew at an insanely fast and healthy rate coming out of the production hell of Model 3 and profitability was imminent. However, if one looked at the Twitter traffic and the amount of sniping against Tesla, it was crazily high, which was the opposite representation of the actual execution of the business. Therefore, in those years, the stock price is extremely volatile along with negative headlines every day. People then conflated the volatility of stock price with the risk of the business, which was actually not in control of the people running the company like Elon Musk, but firmly in the hands of hedge funds and market manipulators who make money by spreading fear and misinformation shorting the stock. These funds have the incentives to make short-term money by manipulating the market by driving up volatility, which has worked well for many years. This explains why the short-term stock price might not reflect the actual business. Retail investors, retirement funds, hedge funds, index funds, and algorithm-based trading funds collectively determine the stock price with different investment horizons and incentives. However, in the long run, growing profits of the business will push the price up. For example, if a business is making $10 million in profit while only valued at $9, 10, 20 million, it is a very good bargain to own the business. There has to be a point where the valuation of the company cannot stay low any longer if the fundamental business is so profitable. The stock price is going to squeeze up no matter how much short-term capital pressures the stock, long-term and value investors will pile in followed by large funds, creating an upward momentum, which exactly happened to Tesla from 2019-2021.

Therefore, Tesla is not a risky stock. It is fundamentally a very safe stock to invest in for long-term capital gain. Even with a higher fluctuation in stock price than most companies in the S&P 500, it is a strong business with a great leader and projected to grow at over 50% in the next 5-10 years with market-dominating products and insane profitability (even before launching robo-taxi). It is clear that the price fluctuation is not an indication of the risk regarding the fundamental business, but only a representation of the polarization of opinions regarding the future outlook of the company as well as Elon Musk’s character, the manipulability of the public sentiment on the company, and the nature of short-term incentives and mindset for most funds and retail investors. Scratching the surface and understanding what defines the risk of stock with a long-term thinking mentality might alter your thoughts towards some seemingly high-valued and volatile stocks. While many growth companies might not sustain the insane valuations after the bull run since the pandemic, a small number of companies with solid fundamentals and amazing products will continue to grow and boom even when the tide turn against them. Among these companies, Tesla is winning the next decades on the path towards becoming the world’s largest company with a visionary leader Elon Musk, building his business empire to bring the planet to sustainable energy and humanity multi-planetary.

However, is it a good decision to all-in Tesla at an investment strategy level? Or do I have to distribute my investment into a diverse portfolio? In the next article, I will debunk the reason why I stay basically all-in on Tesla stock and some dirty truth about portfolio investment theory. Stay tuned.

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