On Wednesday afternoon, Tesla (NASDAQ:TSLA) stock traded higher after the company reported third-quarter earnings. But Tesla shares often have a mind of their own. So it’s always a good idea to sit down and take an objective look at the numbers.
I’ve been a TSLA stock skeptic for a long time. But I’ll be the first to admit that the company’s third-quarter numbers look pretty good. Tesla’s business clearly seems to be on the right track given it is finally delivering profits and actual growth.
Unfortunately, as expected, there was absolutely nothing in Tesla’s third quarter that justifies a more than 700% increase in market cap compared to a year ago. As impressive as Tesla’s third quarter was, investors still shouldn’t be gambling with TSLA stock at its current valuation.
The Numbers For TSLA Stock
Given the insane rally in TSLA stock in the past year, it’s safe to say most Tesla investors are much more about the long-term Tesla story than the quarterly numbers. But those quarterly numbers will ultimately dictate the long-term story.
Tesla reported third-quarter adjusted earnings per share of 76 cents, beating consensus analyst estimates of 57 cents. Revenue of $8.77 billion also topped analyst expectations of $8.36 billion. In the same quarter a year ago, Tesla reported EPS of 37 cents and revenue of $6.3 billion. Revenue in the third quarter was up 39% compared to a year ago. Previously reported vehicle deliveries for the third quarter were 139,300, up 53.6% compared to the second quarter.
Auto gross margins in the quarter were 27.7%, up 2.3% from last quarter and 4.9% from a year ago. Free cash flow for the quarter was $1.395 billion, up 276% from a year ago.
Tesla also slightly decreased its reliance on regulatory credit sales. Tesla reported $397 million in regulatory credit sales, down 7% compared to the second quarter. However, for the fourth consecutive quarter, profits from regulatory credit sales accounted for more than 100% of Tesla’s net income on a generally accepted accounting principles (GAAP) basis. This regulatory credit income will eventually drop to zero as competitors roll out their own electric vehicles in coming years.
In a nutshell, Tesla’s quarter was maybe the most impressive quarter in recent memory for the company. However, the company is still struggling to generate meaningful profits, even when relying heavily on regulatory credits.
In my opinion, Tesla should get a lot of credit for reporting a profitable quarter in a difficult environment. But the company is going to have to do a lot better to justify upside for the stock at a market cap of nearly $400 billion.
Tesla’s Valuation Problem
Once you get past the growth numbers, the reality check for TSLA stock is always its valuation. Tesla originally said it would easily deliver 500,000 vehicles in 2020. CEO Elon Musk recently dialed back those expectations to a range of between 477,750 to 514,500 deliveries.
In 2019, General Motors (NYSE:GM) delivered 7.7 million vehicles, or about 15 times what Tesla hopes to deliver this year. Yet somehow Tesla’s market cap of $393 billion is about 7.7 times the size of GM’s at around $51 billion.
TSLA stock bulls like to argue that Tesla is more like a high-growth tech stock than an auto stock. I recently compared Tesla’s valuation to both auto peers and high-growth big tech peers like Apple (NASDAQ:AAPL), Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN).
At 128x forward earnings and 15.6x sales, TSLA stock is overvalued no matter which group you compare it to.
How To Play Tesla
I’m happy TSLA stock investors got the big quarter they were hoping for. Unfortunately, Tesla’s crazy bubble valuation still makes the stock closer to a casino bet than a sound long-term investment.
If Tesla keeps putting up the kind of numbers it put up in the third quarter for the next 10 or 15 years, it will eventually grow into its valuation. But no investor wants to wait out a decade of potential underperformance while a company’s fundamentals catch up to its stock price. Even if Tesla is the next Apple, Apple hasn’t had a single year in the past 20 in which it had an annual gain of more than 201%. TSLA stock is up 737% in the past year.
Tesla investors must face the fact that the stock has been caught in an electric vehicle bubble. The company’s third-quarter numbers suggest it’s on the right track for long-term growth. But the stock is just as likely to drop 50% in the next several years than it is to gain 50%. Its valuation comes from a story, not a business. If the story doesn’t play out exactly the way investors anticipate, the stock could drop. If investors find another story they like better, the stock could drop.
Tesla put together a great quarter, but there’s no need to gamble by buying at these levels. I’m not going long or short TSLA stock any time soon.
On the date of publication, Wayne Duggan held a long position in GM.
Wayne Duggan has been a U.S. News & World Report Investing contributor since 2016 and is a staff writer at Benzinga, where he has written more than 7,000 articles. He is the author of the book “Beating Wall Street With Common Sense,” which focuses on investing psychology and practical strategies to outperform the stock market.