9/17/13 – A Look at Apple and Tesla: Cool Technology and Market Value

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Sep 17, 2013 10:36:15 AM

and tagged Investing, Market Updates

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My wife, Nora, is a gadget freak. She had (and used) a PalmPilot. She is all over her iPhone. She used her MacBook Air laptop so much and so effectively that I ended up getting one as well. She has a TDI Clean Diesel VW and optimizes her mileage with the way she drives.

I’m not as much of a gadget nut. (I never really did get the PalmPilot working, for example.) I tend to live my tech life by the motto “You can tell the pioneers by the arrows in their backs.” When the bug bites, though, it bites hard. When I saw the ads for the iPad, I knew it was a game changer and ordered one right away. It arrived the day before we went on a long trip, and I remember sitting on a bus, watching our progress against a map on the screen and marveling at how cool it was.

Time passes, and my son, Jackson, now has that iPad most of the time. (It’s “his,” he will have you know.) While I still use the iPad every day to read, watch movies, and play games, it’s no longer cool but, rather, useful. This is a big distinction.

I was thinking of this in terms of the reviews of the latest iPhones, which were seen as more of the same. For Apple, the shift from being judged on “coolness” to being judged on functionality and features is a sea change—and probably a cause of its declining stock price over the past year. I bought the original iPad as a unique product, with no substitutes, which certainly isn’t the case these days.

Right now, the cool product for me (and a lot of other people) is the Tesla electric car. One of our advisors apparently has one, with the Commonwealth web and trading tools running on the car’s internal iPad, which is really cool. I haven’t driven one yet, but after perusing the Consumer Reports reviews, seeing a couple in the wild, and just hearing about it, I want one. Badly.

Making the jump from wanting the car to buying the stock, however, is a step I’m not willing to take. Tesla has skyrocketed more than 400 percent in the past year, per Google Finance, to a current share price around $165. There’s quite a bit of controversy over whether this share price is reasonable, or even sane. Obviously, the people buying the stock at this price expect it to go even higher.

Benjamin Graham, one of the founders of the field of securities analysis, famously described the market as a voting machine in the short run and a weighing machine in the long run. Short-term, the voters have driven up Tesla’s stock price. Longer-term, will it be able to develop the weight?

A professor at NYU’s Stern School of Business, Aswath Damodaran, has put together a valuation model of Tesla, which is worth a look for a couple of reasons. First, it’s an example of the kind of analysis a professional analyst would do. Second, it’s an example of how to think about a stock, as opposed to a company or a product. These are all very different but interrelated things: a great product may not be made by a great company, and a great company, even one with a great product, may not be a great investment. Cue the Apple chart for the past year again.

Tesla offers a very good window into these issues, as Professor Damodaran makes clear. Great product, very cool. Company apparently well organized, but still in growth mode. Financials still evolving. Any valuation depends on what the company does in the future, not on what it’s doing right now. At the same time, any assumptions about the future have to be based on what the company is doing right now.

I won’t try to summarize the analysis; instead, I’ll simply say that its assumptions seemed generous to me—even optimistic—pretty much across the board. One of the things you learn in doing financial models is that a systematic lean one way, optimistic or pessimistic, can compound over multiple assumptions until the end result is far more skewed than any of the individual assumptions alone. So, I was concerned about the apparent optimism of the analysis. Yet, even if his assumptions are systematically optimistic, the professor’s estimated value of around $67 per share is still nearly $100 below Tesla’s current price, which is $165.74 as I write this.

Professor Damodaran understands perfectly well that any assumption is just that, so he also did a sensitivity analysis, with a range for each of the assumptions, which generated a range of possible values for Tesla shares. The range went from $0 (actually less than that, but $0 is the practical lower bound) up to $600 per share. The current price is around the 90th percentile. Based on the model, then, it’s certainly possible that the company could be worth the current share price, but it’s a relatively low-probability event. And it’s even less likely that the company could be worth more than the current price. That’s something important to be aware of before making any investment.

The final point I’ll make here is that the comments on the analysis are very interesting. For anyone who was paying attention during the dot-com boom, there is a definite sense of déjà vu reading many of them. Just because something is possible, or desirable, or cool, doesn’t mean it’s a good investment, or even that it makes financial sense.

As a coda, I would also note a story in today’s Wall Street Journal, “GM Developing Car to Rival Tesla.” Regardless of how cool Tesla is, you know competition is coming. What Apple is facing today, Tesla will face tomorrow. Any valuation or investment decision should also take that into account.

This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

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