Last week, Tesla CEO Elon Musk made an unusual announcement that may have caused some investors to raise their eyebrows. He revealed that the company plans to focus on reducing profits. The rationale behind this decision is that Tesla wants to keep cutting the prices of its vehicles, even if that means earning less profit in the short term, to gain more market share. This move caused a 12% dip in Tesla’s stock price in just one day, leading some investors to wonder if this presents an opportunity to buy shares at a discounted price.
Incredible Margins and 42% Growth
Vertical Integration Advantage
Tesla has an advantage over its competitors in terms of vertical integration. The company produces its own batteries, self-driving software, and charging stations, which translates into net margins that other automakers cannot match. For instance, in 2022, Tesla’s net margin stood at 15.5%, while Toyota’s was at 6.9%, Honda’s at 4.80%, and Ford’s at -1.4%.
Tesla’s revenue has grown by 42% annually over the last five years, reaching $81.5 billion in 2022, a significant increase from $7.0 billion in 2016. The company’s net income has also risen sharply from -$0.8 billion in 2019 to $12.6 billion in 2022, while its free cash flow has increased from -$1.6 billion in 2016 to $5.8 billion in 2022.
Thanks to these impressive financials, Tesla has amassed significant cash reserves that allow it to make price cuts that its competitors can’t match. This puts the company in a position to dominate the electric vehicle (EV) market.
“Tremendous” Future Profits
Tesla’s strategy of reducing profits may seem counterintuitive, but it’s part of a broader plan. Musk wants to become the market leader in autonomous driving vehicles, which he believes is possible because no other company has the same “strategic advantage.” Tesla is the only automaker that’s currently making cars that could sell for zero profit now and yield tremendous profits in the future through autonomy.
Dominating the EV Market
Tesla has already captured 65% of the EV market. If the company could also become the leader in self-driving “robotaxis,” it could see its share price skyrocket.
Is Tesla Stock a No-Brainer Buy?
High Share Price
Despite Tesla’s massive profits and a 59% dip in its share price, buying into the company remains expensive, with a single share currently costing $165. This translates to a price-to-earnings (P/E) ratio of approximately 48, which may appear high when compared to other carmakers.
The Biggest Risk
The biggest risk for investors is whether Tesla’s growth can continue. While the company is currently growing its revenue at 40% per year, its focus on reducing profits to gain market share may not pay off in the long run.
The Bottom Line
If Tesla’s ambitious plans come to fruition, the company’s share price could soar even higher. However, the high share price and uncertainty surrounding the company’s strategy make it a risky investment. As Warren Buffet said, “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”