Tesla Valuation

September 16, 2023

I have been doing some work on equity risk premiums and country risk premiums and was given a reference to Aswath Damodaran and his website. One of his papers was a case study on valuing Tesla.

Price vs value:

• value is determined as the present value of a rational forecast of future cash flows
• price is determined by supply and demand in the market place

Considerations for valuaing young companies:

• expected cash flow from existing assets
  • typically a five-year horizon for companies with supernormal growth, which can be extended
  • estimate revenue growth rate
    • consider overall market, in conjunction with the individual companies' strengths and weaknesses
  • forecast target operating margin
    • what is comparable in the industry, and what will the company converge on as it matures and takes advantage of economies fo scale
  • estimate of investment required to achieve forecast growth
    • invested capital (and its change)
    • sales to capital ratio
      • a higher ratio is reflective of higher quality growth
• expected growth (operating income)
  • the value effect of growth will depend upon how efficiently that growth is generated in terms of required investment
• discount rate
  • cost of capital when valuing business
  • cost of equity when valuing equity
  • the risk of young firms is company-specific and should be diversifiable at the portfolio level
  • survival risk is better considered explicitly
  • in the case of Tesla, this is approximated using the weighted average of the betas of the technology and automobile sectors, with the weights shifting to the latter as the company’s revenues increase
• terminal value
  • estimated value of firm at the end of the forecast period
  • assuming cash flows will grow at a constant rate
  • introduce an estimated probability of failure, with the proceeds from the failure being used to compute an expected value

Impact of noise trading:

• noise traders are subject to bouts of sentiment, which may drive the spread between stock prices and fundamental value
• evaluate by looking at the ratio of individual share holdings to institutional holdings and the ratio of shares sold short to shares outstanding
• short interest decreases at start of run-up
  • short sellers are capital constrained so that when losses accumulate they cannot meet continuing margins calls and are forced to cover their positions
  • short sellers become aware of the added volatility of the stock when the run-up begins and are unwilling to maintain the level of their short positions in the face of the higher perceived volatility
• short interest increases towards end of run-up
  • if fundamental investors perceive the overvaluation to be large enough, the higher expected returns of selling short become sufficient to overcome the capital constraints and perceived risk