Tesla’s remarkable share price is one of the most fascinating financial stories of modern-day times
by Andy Davis
Share price movements are usually understood as indicators of a company’s prospects and how favourably investors view them.
On that basis, the share price of Tesla, the pioneering US maker of electric vehicles (EVs), is arguably one of the most interesting pieces of financial information in the world today.
What could Tesla’s extraordinary ascent to a US$1tn market capitalisation signify? On the day in October 2021 when its valuation passed that milestone, the company’s market capitalisation was on a par with the next ten biggest automakers in the world combined.
The explanation you will hear most often for this bizarre situation is that speculation is running wild. Certainly, the company led by Elon Musk was borne aloft on a tidal wave of stock market speculation during 2021, fuelled in large part by retail investors. This interpretation is founded on the fact that many of Tesla’s loudest advocates resemble religious zealots as much as private investors. It is a company that divides people like few others. Most commentary on its performance and prospects comes either from true believers or from ultra-sceptics, who refuse to admit their scepticism is fuelled by anger that they did not buy the shares and so have had to watch the true believers make enormous gains.
In fairness, Tesla’s share price is undoubtedly an index of market froth. But there is more to this story than simple speculative excess.
Back to the beginning
The car market today is in the early stages of a similar transformation to the one that unfolded in the music market from the mid-1980s onwards. Back then, we were beginning a replacement cycle in which one technology standard (CDs) replaced others (vinyl and cassettes). The process took years, but the outcome was never in doubt.
US investors have seen technology companies achieve undreamed-of valuations
Electric motors are clearly going to replace internal combustion engines – the only question is how long it will take. Transport has been through numerous replacement cycles and history suggests that some, at least, can be swift. I recently came across a pair of photographs of the Easter morning parade in New York. The first, dated 1900, featured a lone car among the lines of horse-drawn carriages. In the second, from 1913, it was impossible to spot a single horse among the cars.
Even so, to borrow an analogy from the music industry, Tesla’s share price seems to be suggesting that this company owns 95% of the CD production capacity on the planet and will therefore monopolise the gains from this latest replacement cycle.
Given that Tesla has no monopoly on EVs and could never hope to produce enough of them on its own to supply all the demand that the next ten biggest carmakers currently meet, that interpretation cannot be correct. And that is without acknowledging that in many markets, including the UK, there are major obstacles to the rapid spread of EV ownership, notably the lack of charging infrastructure for people who must park on the street.
Alternatively, perhaps Tesla’s acknowledged lead in the software and technology needed to enable autonomous vehicles might explain its massive valuation. This is possible, but there are caveats. Autonomous vehicles have been hugely over-hyped. The computing challenges are vast, bigger even that Musk himself initially realised. “I didn’t think we would have to solve a significant part of artificial intelligence to make it work,” he told the Financial Times in December 2021. Viable, mass-market autonomous vehicles are still years away.
Three reasons
Why then, has Tesla’s share price gone so high? Here are three reasons, although there are probably more.
First, its home market is the US. Having an enormous and wealthy domestic market to go after is a massive advantage for any company, especially a pioneering one – look at what Henry Ford and his peers achieved in the previous replacement cycle a century ago, from horses to internal combustion engines.
Equally important, US investors are culturally inclined to back moon-shot ventures like Tesla that consume copious capital. They have seen their most successful technology companies achieve undreamed-of valuations and not unreasonably they believe the same can happen again, especially during a period when conventional investments offer such meagre returns.
But probably the most important explanation for the extraordinary story of Tesla’s share price is the company’s founder, Elon Musk. In him, Tesla has an entrepreneurial visionary and engineering genius who also happens to be an unrivalled showman and booster for the social media age. Tesla’s valuation looks insane by any conventional yardstick. But it is telling a powerful story very clearly: investors believe that Elon Musk is the right entrepreneur, with the right idea, in the right place at the right time.
The lesson of history is that because Tesla has the US market as its primary target, US investors to back it, and an entrepreneur for the ages to run it, this company has a better opportunity than any other at this moment to justify that stratospheric valuation.
Views expressed in this article are those of the author alone and do not necessarily represent the views of the CISI. The writer has no direct position in Tesla shares and never has done. He does have positions in exchange-traded funds tracking indices that include Tesla.
This article is published in the March 2022 edition of The Review.
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