Episode 29 | Tesla: Innovation and Valuation

In Episode 29 of “Market News with Rodney Lake,” Rodney Lake, Director of the GW Investment Institute, discusses Tesla’s potential, highlighting Elon Musk’s significant stake in the company and his ability to drive its success despite managing multiple ventures. The episode covers Tesla's high valuation, fueled by growth expectations in Full Self-Driving software, energy storage, and AI. Despite these lofty expectations, Tesla’s balance sheet remains strong, with substantial cash and free cash flow. Analysts are encouraged to consider the company’s long-term growth potential, particularly in applying artificial intelligence in the real world, energy solutions, and robotics. Tune in now!

Transcript

Thank you for joining Market News with Rodney Lake. This is a regular program for the GW Investment Institute where we talk about timely market topics. I'm Rodney Lake, the director of the GW Investment Institute. Let's get started.

Welcome back to Market News with Rodney Lake. I'm your host, Rodney Lake. Today’s episode is very important. It is after the inauguration, so we’re into 2025. The new administration is in place, and let’s see what happens there. Stay tuned. We’ll talk a little bit more about that.

Now we’re going to talk about a company today that is highly connected to the administration. At least one person is, maybe not the company, but the company is Tesla. And their CEO is Elon Musk, who’s been very prominent in this new administration. So let’s dive into the company.

So as you may know, what we’re going to talk about is the framework from the GW Investment Institute. So that is business, management, price valuation, and balance sheet. So if you’re not caught up on that, you know, I encourage you to watch other episodes too if you want to learn about companies. But that’s the framework that we use at the GW Investment Institute. And our students have been very successful with this framework. We took that framework from Warren Buffett and we modified it a little bit. We added the balance sheet. We emphasize things a little bit differently, let’s say, but the same framework is there for anyone to use. And courtesy of Mr. Buffett, generally speaking, and modified by the Investment Institute. So let’s jump in.

So Tesla, everyone thinks, maybe not everyone, many people think that this is a car company. I would offer that it’s not a car company, that this is a technology company, that this is a hardware and software business. And because it’s very different from other car companies, you wouldn’t say that they’re direct competitors with GM. GM does not really build their own software. But from the inception of Tesla, really these people are hardware people. They’re software people. They’re integration people. So it’s a very different setup. And obviously we’re going to talk about some of the different products too. But in the car business, they’ve gotten very popular.

Now, one of the things that just came out is that Trump is mentioning that they’re going to get rid of this mandate for electric vehicles. So we’ll see what the impact is there. Time will tell on that.

But let’s talk about a couple of other things that Tesla does. So on the business side, you know, the most well-known feature is the vehicles. And really that’s what drives most of the sales right now. Some of the other things that are happening at Tesla that are very important—you have the Megapacks and the solar business. And so the Megapacks are utility-scale batteries that help harmonize the grid. And so when you’re adding all these renewables, intermittent sources on the grid, you really need to have these battery backups. That business is growing leaps and bounds, hundreds of percent per year. And so it is really important for us to watch that. Now, it is a smaller part of the business overall, but it is growing much faster than the car business.

And so let’s just really now dive into some of the metrics. And so when we talk about market cap, right now again, after the administration has taken over, in January here, we’re looking at the market cap of $1.3 trillion for Tesla, on revenue of $97 billion. And so when we see that, you know, those are big numbers. And so if you look at gross profit, you know, you’re talking 18%, which is pretty good for a car company. And if you’re looking at, for a manufacturing business, not bad at all.

So let’s look a little bit further. Let’s look at the net income margins—7.5%. Now that seems more like, okay, this is a manufacturing business. And so, but really the scale that they’re getting is enormous. And when you really think about sort of the upside that they have in a few different areas, I think that’s why it’s important to really pay attention to Tesla.

So one of the most important areas to watch that I think—I’m saying it, but opinion—is the Full Self-Driving. So, if you’re out there and you have version 13.2.2 and something else, then you sort of have the newest version out there. And depending on what type of hardware came with your car, whether it’s hardware three or hardware four—about to switch that, they call it i4 and i5 coming out—that’s the cameras and the setup that enables this, plus the software.

And this has become very significant because this can be an enormous driver for the usability of the cars. And so it can make a car go from, let’s say, used one-tenth of the time, it sits idle nine-tenths of the time, to having a car you put on the Tesla network and it drives itself around and picks up people.

And so it goes from a depreciating asset to a cash flow asset for the person who owns that car, owns the software, and owns the rights to that. That is a very significant change and a very big lift in value. And also, even if you don’t consider that, if you just say, “Well, I’m not going to rent it out, but it drives me around,” you basically have a driver now. So if you own that, you effectively have a driver. You get to maybe get some of your time back.

And depending on how fast that rolls out, as far as how fully autonomous that might be, that’s something that could be useful even if you’re not using that time for other people or using your car to have other people use it. It’s the time it saves you. So that’s really significant. But if you put it on the network, again, it goes from a depreciating asset to a cash flow asset. So an important piece to watch.

Plus, they have the fully autonomous cars. That’s the two-seater that was showcased at the end of last year. That’s going to pick people up, basically an Uber with no driver in it. Two seats. Jump in. Something like 80-plus percent of the rides are one or two people. So I think it makes a lot of sense to target a market for a two-seater. Right? Plus luggage, going to the airport. It’s just two people. It’s just you. Many times you take an Uber, you take a cab—if you still take some of those things—it’s you by yourself. Right? I’m going to the airport, my luggage is in there. So a two-seater works fantastic for probably 80-plus percent of the rides.

Next up, they have a bigger transport thing. I think that’s probably a little bit further out, but it’s 20-plus people. We’ll see there. So I think that’s important.

The other piece is that they’re really growing the compute faster than likely almost anyone else on Earth as far as it relates to this product. And so they built a big center in Austin, Texas. They moved the headquarters from California to Texas. Now they have a big compute center in Texas. They’re right on the campus for the full self-driving capabilities. And so I think, again, this is something as an analyst, as an investor, you really need to watch.

And if you look at sort of the progress that’s being made, and what has happened to Tesla over the past year, it’s grown quite significantly—up 100% year over year. Now, as we’re talking about the business, those are things that we really need to pay attention to, and there are significant growth drivers.

I’ll mention one more thing before we move on—and we could really talk at length about a lot of these different segments—but to keep the episode tight, we’re going to talk just about one more, and then we’re going to move on to the other parts of the framework we’ll revisit when we wrap up here.

The next piece that is worth mentioning, and you should be paying close attention to, is Optimus. This is the fully autonomous robot that they’re trying to build. Now, I think everyone would have one of these robots if they get this to work, and they can get it at a price point—let’s say $30,000. I think everyone’s going to have an Optimus robot because, if it can load the dishwasher for you, clean your house, basically have everything done when you get home—your house is clean, your dishes are washed, your clothes are washed and folded, your bed is made—all this stuff that may seem quite mundane but that you’d be happy to pay someone to do.

And let’s say you finance it. It’s a thousand bucks a month. You get it down to 500 bucks a month. I think at a thousand bucks a month, many people are going to have that. At 500 a month, and 250 a month, almost everyone’s going to have that. Right? And I think depending on where the price point goes, I think everyone would buy that product.

So then it gets kind of crazy on the numbers for the market cap associated with that. The total addressable market is effectively everybody on the planet. And so we’ll have to pay close attention to that. I think that’s more upside from here. It’s something to pay attention to.

But certainly, the car business is going strong. The energy business is growing faster than the other parts. In the end, the utility business is way bigger than the car business. So I think that’s something to clearly pay attention to.

For the business, we’ll leave it there for the moment. And again, we could spend an enormous amount of time on any one of those segments. We could really deep dive to talk about the growth trajectory, where they are now, and the capabilities at length.

But moving on to management. So I think we just focus on Musk as the CEO here. And obviously, there are other great people involved that we could talk about. But Musk is the leader of this. He remains a 12% owner of the business and is highly motivated. Founder-led businesses have been successful.

You think about Apple in its heyday and its rise to prominence when Steve Jobs came back. You think about a company like Oracle right now. You think about Berkshire Hathaway—even though Buffett wasn’t technically a founder, he’s sort of the founder of the modern version of Berkshire Hathaway. But these founder-led companies can do well.

Probably the most prominent founder-led company besides Tesla right now would be Nvidia and Jensen Huang. These founder-led companies have been successful because these people are passionate. Obviously, they’re super wealthy already, so at some point, it’s not about the money. It’s about their vision of what they want to do.

And as an investor, if you can tag along for that ride, that is wonderful. As far as alignment of interests—which Charlie Munger talks about all the time—Musk is fully aligned as a shareholder. If you believe in their vision, many of the investors think differently sometimes, but many are in lockstep with Musk.

That’s obviously up to you as an analyst to figure out if you think you’re aligned with the founder and the CEO. Many people are, and there’s a high probability—or maybe not a high probability.

There can be a good, it may be better than a 50/50 probability when you have a founder-led company, that they're really focused on the vision and not just about the money. He has a huge stake in the company as well. His personal fortune is already immense, so he's really trying to drive the company forward. Interests still seem to align with growing the business. He’s been a very capable CEO.

Some of the criticism Musk can get is that he likes to spend time on what was Twitter, now X, and other interests. He's running different companies, and some say he’s spending too much time on SpaceX or X. He has many companies that he's working with, founded, and is leading. This can be challenging for an investor to think about because it's not like anyone else. He’s in a class of his own when it comes to running so many companies at the same time. You need to evaluate it uniquely, as it's not comparable to any other setup. As an analyst, you need to think about whether you’re comfortable with this person running so many things. But right now, the results speak for themselves. These companies have achieved a lot of success.

Now, you can add to this a government job, which I don’t think he’s getting paid for, as co-head of Doge, the Department of Government Efficiency. He’s now helping the government be more efficient on top of everything else. You could say he has too many things going on, and that’s a valid analysis. Most people probably can’t manage all these things at once. But Musk clearly has developed a unique skill set and seems to be good at it. You have to look at him as a one-off and not compare him to others, but you do have to hold him accountable for the results of these companies. It seems many of these companies are pushing ahead and doing well.

When we talk about management, I think we're solidly aligned there. You need to do your own analysis on this. Moving on to price valuation—this is where people get skittish. The forward P/E is 171 times, which is a pretty generous PE even when the price was half that a year ago. Now, it’s really expecting a lot of growth. Some of that expectation is in the full self-driving technology. This valuation is challenging because the company needs to grow a lot to meet it. It also needs to change its profit margin. If the software becomes good enough for full self-driving, the price of that software is going to go up. Right now, it’s about $12,000 as an add-on when you buy a new car, but once it’s safer than a human driver and regulatory approval is there, many people will pay much more than that.

The profit margin on software is very high, as there's zero cost for each new version. Once you’ve paid for the setup, each additional subscription is 100% profit, which drops directly to the bottom line. Thinking about the valuation, Tesla’s current position doesn’t necessarily represent where it’ll be in a year or five years. On both the revenue side (products in the market like the Megapack growing into the utility business) and on the margin side. Not even mentioning Optimus yet. When you think about the margin side and full self-driving software, they also plan to license it to other companies. Licensing is another profitable business because software has high profit margins.

The multiple for this company may not seem as ridiculous when you factor in that margins will increase significantly with revenue drivers that have high profit margins. You also have an enormous business in full self-driving and Optimus, which would give a massive total addressable market. If there’s any uptake in these areas, maybe the P/E doesn’t look as bad. It’s still challenging to think through, though. You really need to consider where Tesla could be in 3, 5, and 10 years. Tesla has been around for about 20 years. Musk has been at it for nearly that long. You need to think about the next decade for Tesla and whether paying 171 times forward P/E now makes sense. It's even more challenging now with the price up nearly 95% year-over-year. People might regret not buying when it was half the price last year.

The margins are something to think about, as well as the total addressable market when considering valuation. It’s challenging, as it is with any business with lots of growth. Think about Amazon, which always looked expensive. But as an analyst, you have to really sit down and think through the optimistic view, the base case, and what happens if they don’t make these things work or only make limited progress.

Now, on the balance sheet, Tesla used to get some criticism, but right now, it’s a very clean balance sheet. The company has $33 billion in cash, $12 billion in total debt, so a net cash position that’s very comfortable. Cash from operations is $14 billion, with free cash flow at $3.6 billion as of September 30, 2024. Capital expenditures are close to $11 billion, and the interest coverage ratio is 57 times. With a net cash position of around $20 billion and positive free cash flow, there’s not much to be concerned about. The numbers are good for a manufacturing business, which needs a lot of capital to build manufacturing centers in places like California, Texas, Germany, and China. It’s not something to be concerned about for now, but you have to keep an eye on it since large capital expenditures can change the numbers, especially if a new plant is built.

Moving on to the business, Tesla is a company people know well. Some are really in love with it, and others think it's overpriced. Tesla is in the car business, but they would argue they’re selling autonomous robots that are not fully autonomous yet. The software isn’t quite there, but they’re upgrading both the hardware and the software, and they're going to continue to improve it. Full self-driving capability is in the works, with customers getting updates just like on a phone.

Tesla also has a growing Megapack business and solar business. The Powerwall retail business is popular and growing. They're setting up virtual power plants, which I didn’t get into, but that’s another hidden gem in their auto bidder software. There are many ways Tesla can extract value from its platforms, especially as it grows into the utility business with more electrified vehicles. They’re great at this and have a lot of potential for growth, both in the car business and other areas like the Megapack and solar energy.

For the business side, I’d give it a 9. For management, I’d also give it a 9. Musk is managing a lot of other things, so maybe that’s why it’s not a 10. For valuation, I’d rate it a 6 or 7, given the high forward P/E. For the balance sheet, I’d give it a 9. Overall, the composite score would be around 8.5, depending on how you rate things. This is a small position at the GW Investment Institute, but it’s something everyone should be thinking about. Tesla is doing very exciting things, even though Musk can be controversial. With the new administration, it’ll be interesting to see how that plays out. As an analyst, you should absolutely be paying attention to this company for a variety of reasons, including Optimus, AI in full self-driving, and energy applications in the electricity business. There’s a lot happening, and it’s reshaping industries. It’s a consequential business, so you should do your own work and keep track of it.

That’s it for this episode. Until next time.

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