Making sense of Tesla’s valuation

I wrote back on August 6th 2016, “Game Rules are Changing”, my thoughts on market predictions and how they could be best summed up in a Warren Buffett quote,

“A prediction about the direction of the stock market tells you nothing about where stocks are headed, but a whole lot about the person doing the predicting.”

Last summer, many investment guru’s recommended that investors should “sell everything”. Goldman Sachs even sounded the alarm on equities. Since that time, the S&P 500 is up around 7% and Financial ETF (XLF), which I highlighted in that post, is up around 20%.

Eventually, all of these warnings will come true. So far many of the most popular prognosticators are well off the mark on their timing to sell. As the markets have risen, the louder these voices have become. If Buffett can’t time the top, I’m sure nobody else has a chance. There is now even a longer line of “experts” sounding the alarm on high equity valuations, out-of-control house prices, and a divided government.

These investors may not realize it, but they are using a top-down approach. Analyzing leading economic indicators, market technicals/sentiment, geo-political events, and monitoring Federal Reserve policies are very difficult to predict.  The investment results are mixed at best for this type of approach. This 20,000-foot view is often used by the financial media due to the ease of communicating this news in quick soundbites.

Leon Cooperman is a hedge fund manager that built his fortune using a bottom-up approach. On Wednesday, Leon said on CNBC that passive management isn’t how famed investors have built their fortunes. He went on to say, “All I know is if the ability to underperform exists, the ability to outperform also exists.” Fundamental stock analysts make decisions based on the next 3-5 years. These analysts have all been grouped together and branded as inferior to passive management (buying ETFs). It is unfortunate that active managers have been labeled as not worth the higher expenses.

I am going to highlight an extreme example of the difference between a top-down and bottom-up approach investor. As a policy, I never discuss individual stocks or give advice in my posts because there is too much liability. The following commentary is not a buy or a sell recommendation and at this moment I have no position in this company.

This week Tesla passed Ford in market capitalization. Tesla, delivered 25,000 cars globally last quarter, while Ford sold 617,302 vehicles. Tesla is also close to passing GM in total value. Last year, GM made a profit of almost $10 billion, and Tesla had total sales of only $7 billion. This example has many investors utterly confused.

Investors who have bet against (shorted) Tesla have taken a top-down view. They have misjudged as a result of taking a snapshot of the company from this point in time. Using a bottom-up approach, a fundamental investor has projected cash flows 3-5 years into the future. The Tesla story is feasible, if they can deliver on selling 400,000-500,000 Model 3 vehicles.

I use a bottom-up approach. I actively manage my clients’ portfolios with an eye on the next 3 years. At this point in time, from the top-down, the market does seem as though there is a high probability for a correction. However, using a bottom-up approach, the profit picture still looks positive for many companies regardless of what the Fed announces or what happens in Washington. I just hope that that these top-down investors continue to be off on their timing.

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