On Wednesday, 25th of January, the financial results of the largest electric car manufacturer Tesla (Tesla) were announced. Earnings per share EPS came in better than analysts' consensus at USD 1.19 (USD 1.15 was expected). Since then, shares in Elon Musk's company have risen more than 23% in just three sessions. The day after this event, Aswath Damodaran, a professor at the University of New York and also one of the foremost experts in corporate valuation, decided to present his calculation of the value of this company. What were the results of his valuation?
Who is Aswath Damodaran and what is his methodology?
Aswath Damodaran teaches stock valuation and business risk at New York University. He previously worked as a financial analyst at investment banks. He has a PhD in finance and has authored several books and articles on equity valuation and risk management. His knowledge and experience in the field are widely recognised, making his opinions highly valued in the financial world.
His approach is based on sound theoretical and practical foundations and share valuations are often considered to be very accurate and relevant, although of course they can be susceptible to various factors such as market changes or unexpected events.
Damodaran bases his method on fundamental analysis, which involves assessing a company's financial performance and growth potential to determine the value of its shares. He takes into account various factors such as the market situation, competition and risk, using various valuation models, including the DCF (Discounted Cash Flow) model. In literally a few words, DCF is one of the most popular share valuation models, which involves determining the value of the future cash flows that a company would generate and converting them into present value. This is done by taking into account a discount rate that reflects the risk associated with the investment. The discount rate is a (percentage) rate that takes into account the fact that money that could be received in the future is worth less than money received at a given point in time. A high discount rate means a higher risk of investment and a lower present value of future cash flows. This allows the model to determine the value of the company and its shares.
Tesla's financial report
Despite the global slowdown and the severe situation for the automobile manufacturing industry due to global inflation, the company's revenues increased by 33% year-on-year, despite the company's operating expenses falling by 16% year-on-year. This appears to have caused the company's net profit to increase by 58% year-on-year, with operating margin up 16% (previously 14.7%) against an industry average of 8%. Production volumes, meanwhile, increased by 44% year-on-year.
Source: 2022 Q4 Tesla Quarterly Report
'Tell me a story', or the valuation of Tesla shares
The author had already done a valuation of Tesla in 2013 and found it to be heavily overvalued at the time. In retrospect, he identified three mistakes he made in his early valuations. He admits that he was wrong in assessing the growth potential by limiting the product reach mainly to the US consumer. Damodaran also points to an error in assessing product characteristics, treating Tesla's cars as ordinary cars rather than electronic products with software, and a misjudgement of investment needs, failing to consider that Tesla manages to generate growth without large-scale investment in factories.
At the company's current valuation, Damodaran has assumed that the company's average annual revenue growth over the next five years would be 24%, after which it will stabilise to an average annual growth rate of around 3.5%. During this period, the operating margin would gradually decline from 18% to 16%. The previously mentioned cost of capital, or expected minimum annual return on capital, is currently 10.15% (against the current market average of 10.75%) in the first period, before normalising to 9%. Under these key assumptions, the intrinsic value of a single Tesla share is $129.72, 27% below the last closing price. However, due to the uncertainty in estimating the future, Damodaran decided to do a breakdown against the use of different rates of return, the amount of growth in the company's sales and operating margins. From this type of analysis, it came out that with a probability of 80%, the company could be worth more than US$84.53 per share and less than US$159.41. The highest possible value from the model, under the most extremely optimistic assumptions, per share is US$328.4.
Source: Conotoxia MT5, Tesla, Daily
Grzegorz Dróżdż, Market Analyst of Conotoxia Ltd. (Conotoxia investment service)
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