StrangeCosmos valuations out of MA

[Esme Es Mejor]

Yes, exactly, thank you. We should of course expect some amount of growth to be priced in. The market prices stocks based on expected future profit and cash flow, informed by management guidance and analyst modelling. An important question for Tesla, then, is: how much growth is currently priced in? Or, to put it another way, how much of the valuation is not based on growth, but based on current cash flows?

Well, the answer I found is $20 billion. $20 billion is justified by current cash flows, and the other $30-40 billion is the growth premium.

In spite of the Disagrees you’re getting, I appreciate what you’re doing. Or, at least, what I think you’re doing.

Up until the Q3 earnings, bears could argue that Tesla was worth $0. That was short-sighted, but based only on the cash flow, it made sense. Now, the worst-case scenario— in which Tesla grows at the industry average rate of 1.6%— is that Tesla is worth $20 billion.

Of course, Tesla is growing much faster than that— about 35x faster than that. But even the most bearish of bears has to admit the company is worth at least $20 billion. Which is a nice improvement over 8 days ago.

PS— I think your title would benefit from the word “alone.” As in, “Based on Cash Flow Alone, Tesla is Worth $20 Billion”

 

[Fact Checking]

I just published this article: Based On Q3 Cash Flow, Tesla Is Worth $20 Billion

Summary

• Tesla is worth $20 billion today, based on the cash flow multiples of major automakers.
• But Tesla is also growing 41x faster than those other automakers.
• Profit is a different story, although that should change at least somewhat in the coming quarters because of how Tesla calculates depreciation.

There's a large number of methodological flaws in your ~$20b valuation models, even under the "no growth premium" assumption (which assumption is ridiculous in itself):

• 1) Tesla's Q3 cash flow includes -$500m growth oriented capex outflow, yet your FCF estimate doesn't account for it:
  • "In Q3, Tesla’s free cash flow was $881 million. That’s $3.5 billion annualized. On a 16.6% free cash flow yield, Tesla would be valued at $21 billion. $19.6 billion and $21 billion average out to $20.3 billion."
• So if you assume "no growth", you have to take out the heavy growth related investments Tesla is performing. You cannot have it both ways: assume no growth but burden FCF with capex outflow ...
• 2) "Traditional auto OEMs" like GM gain a significant amount of their cash flow and profits from their 'captured' financing arm like 'GM Financial'. These are essentially corporate-owned banks that handle auto loans and leases, which financing makes up like 80% of the new car sales in advanced economies. Much of GM's profit comes from 'GM Financing'. Tesla doesn't make use of such captured financing arms yet - it doesn't even offer a leasing option for the Model 3 yet. Still your valuation includes those cash flows on the side of traditional auto - while you don't include it on the Tesla side. If you want to create a valid comparison on this basis you either need to subtract financing income from traditional auto, or estimate and add it in on the Tesla side.
• 3) You make a similar mistake on the GAAP profit side as you made on the free-cash-flow side: you include depreciation & amortization costs while in reality they are out-sized compared to other car companies and related to future growth. You cannot have it both ways.
  
• 4) In the static no-growth model you don't even attempt to value the very significant intangibles that Tesla already owns today. AutoPilot alone is probably already worth $20b in its current state, possibly more - and Tesla could make a very nice stream of income if they licensed it to other carmakers whose in-car software environment is often a decade behind that of Tesla's.
• 5) Tesla owns a valuable franchise/monopoly in the 'premium EV market' with products that have no easy substitutes on the market, which results in the economic advantages franchises/monopolies enjoy in other sectors: high margins, price setting power, flow of demand advantages and better recession resilience. These are significant economic factors that valuation models of franchise owners all try to include - yet you ignore these qualities and compare Tesla to incumbents in the largely commoditized, low margin ICE automotive sector?
• 6) ICE incumbents have various liabilities (Diesel-fraud exposure and future liabilities for example) and growth concerns: obviously the ICE engine, which is the central part of their business value, is not a going concern in the long or even medium run and is a significant growth or even shrinkage risk of business. Yet you don't even mention these factors of why the P/E factors of ICE automotive sector are so depressed ...
  
• 7) You didn't disclose the various limits GAAP metrics have when valuing Tesla, which limitations were pointed out to you here on TMC by @neroden, but also by me.

But it gets worse: none of this should be news to you, as it has been pointed out to you in this thread when you floated your article idea a couple of days ago.

In writing your SA article you have almost entirely ignored the feedback given by @neroden, me and others, and you ended up writing a flawed SA article with an inflammatory headline based on what appears to be an unshakeable preconception that no amount of counter arguments or facts appear to have been able to change. In your article you also mention a couple of higher valuation models, but those are similarly incomplete and they obviously don't fix the misleading headline and the misleading initial part of your article.

Basically in your article you are comparing a barrel of artisan wine to a barrel of tap water using the pricing of tap water - it's a meaningless, misleading and intellectually dishonest comparison.

 

[scaesare]

More like incredibly accurate and straightforward title.

Because it’s truthful and factual, and non-clickbaity.

It seems to be the accurate result of what appears to be a flawed model.

 

[dqd88]

There's a large number of methodological flaws in your ~$20b valuation models, even under the "no growth premium" assumption (which assumption is ridiculous in itself):

• 1) Tesla's Q3 cash flow includes -$500m growth oriented capex outflow, yet your FCF estimate doesn't account for it:
  • "In Q3, Tesla’s free cash flow was $881 million. That’s $3.5 billion annualized. On a 16.6% free cash flow yield, Tesla would be valued at $21 billion. $19.6 billion and $21 billion average out to $20.3 billion."
• So if you assume "no growth", you have to take out the heavy growth related investments Tesla is performing. You cannot have it both ways: assume no growth but burden FCF with capex outflow ...
• 2) "Traditional auto OEMs" like GM gain a significant amount of their cash flow and profits from their 'captured' financing arm like 'GM Financial'. These are essentially corporate-owned banks that handle auto loans and leases, which financing makes up like 80% of the new car sales in advanced economies. Much of GM's profit comes from 'GM Financing'. Tesla doesn't make use of such captured financing arms yet - it doesn't even offer a leasing option for the Model 3 yet. Still your valuation includes those cash flows on the side of traditional auto - while you don't include it on the Tesla side. If you want to create a valid comparison on this basis you either need to subtract financing income from traditional auto, or estimate and add it in on the Tesla side.
• 3) You make a similar mistake on the GAAP profit side as you made on the free-cash-flow side: you include depreciation & amortization costs while in reality they are out-sized compared to other car companies and related to future growth. You cannot have it both ways.
  
• 4) In the static no-growth model you don't even attempt to value the very significant intangibles that Tesla already owns today. AutoPilot alone is probably already worth $20b in its current state, possibly more - and Tesla could make a very nice stream of income if they licensed it to other carmakers whose in-car software environment is often a decade behind that of Tesla's.
• 5) Tesla owns a valuable franchise/monopoly in the 'premium EV market' with products that have no easy substitutes on the market, which results in the economic advantages franchises/monopolies enjoy in other sectors: high margins, price setting power, flow of demand advantages and better recession resilience. These are significant economic factors that valuation models of franchise owners all try to include - yet you ignore these qualities and compare Tesla to incumbents in the largely commoditized, low margin ICE automotive sector?
• 6) ICE incumbents have various liabilities (Diesel-fraud exposure and future liabilities for example) and growth concerns: obviously the ICE engine, which is the central part of their business value, is not a going concern in the long or even medium run and is a significant growth or even shrinkage risk of business. Yet you don't even mention these factors of why the P/E factors of ICE automotive sector are so depressed ...
  
• 7) You didn't disclose the various limits GAAP metrics have when valuing Tesla, which limitations were pointed out to you here on TMC by @neroden, but also by me.

But it gets worse: none of this should be news to you, as it has been pointed out to you in this thread when you floated your article idea a couple of days ago.

In writing your SA article you have almost entirely ignored the feedback given by @neroden, me and others, and you ended up writing a flawed SA article with an inflammatory headline based on what appears to be an unshakeable preconception that no amount of counter arguments or facts appear to have been able to change. In your article you also mention a couple of higher valuation models, but those are similarly incomplete and they obviously don't fix the misleading headline and the misleading initial part of your article.

Basically in your article you are comparing a barrel of artisan wine to a barrel of tap water using the pricing of tap water - it's a meaningless, misleading and intellectually dishonest comparison.

There needs to be an emoji button for "brutal takedown"

 

[oneday]

There needs to be an emoji button for "brutal takedown"

 

[strangecosmos]

There are some people who just can’t tolerate disagreement, who get angry and resort to insults and name-calling when someone disagrees with them. I am often tempted to respond, especially to point out factual errors (e.g. free cash flow is a non-GAAP metric; assets are not cash flow), misunderstandings (e.g. inputs to a toy model vs. genuine beliefs or predictions; present vs. future cash flow), and dubious assumptions (e.g. Tesla is an eternal premium EV monopoly). But there is no point engaging because when there is no tolerance for disagreement, there is no room for real discussion. It isn’t “winning” or “pwning” to be so rude and aggressive that people no longer want to talk to you. By that measure, Internet trolls are the most brilliant debaters of our time.

I would rather be civil and wrong than abusive and right. And I would rather people think I’m wrong than engage with someone who is so emotionally invested in being right that they feel they have to verbally abuse anyone who disagrees with them.

 

[oneday]

There are some people who just can’t tolerate disagreement, who get angry and resort to insults and name-calling when someone disagrees with them. I am often tempted to respond, especially to point out factual errors (e.g. free cash flow is a non-GAAP metric; assets are not cash flow), misunderstandings (e.g. model inputs vs. genuine beliefs or predictions), and dubious assumptions (e.g. Tesla is an eternal premium EV monopoly). But there is no point engaging because when there is no tolerance for disagreement, there is no room for real discussion. It isn’t “winning” or “pwning” to be so rude and aggressive that people no longer want to talk to you. By that measure, Internet trolls are the most brilliant debaters of our time.

I would rather be civil and wrong than abusive and right. And I would rather people think I’m wrong than engage with someone who is so emotionally invested in being right that they feel they have to verbally abuse anyone who disagrees with them.

You’re right. We should be able to have reasonable discussions around our disagreements. And my comic was kind of piling on, meant as a joke, but perhaps just kind of immature which makes it, unfortunately, less funny.

I do think @Fact Checking broke down your article pretty well though, no? The point that hit home for me, was how your valuation theories took up a few pages of market action before your article came out. When you brought it up then, it mostly was pages of people disagreeing with you. So then to link your article and resume the discussion again in market action, was somewhat frustrating.

I am glad your valuation ideas now have their own thread.

 

[dqd88]

There are some people who just can’t tolerate disagreement

Dude, this describes you perfectly. You post your article, and when people give their opinion, you shut it down instantly and are not open to it. You act like you are 100% right and that's that. Take a good look in the mirror.
But hey you got the clicks you wanted

 

[strangecosmos]

I do think @Fact Checking broke down your article pretty well though, no? The point that hit home for me, was how your valuation theories took up a few pages of market action before your article came out. When you brought it up then, it mostly was pages of people disagreeing with you. So then to link your article and resume the discussion again in market action, was somewhat frustrating.

In my view, Fact Checking uses bully tactics. When someone disagrees, they insult and call names. They treat their own opinion as fact, and any dissenting opinion as stubbornness. When someone makes what I think is a good point, I’m grateful and I incorporate that into my thinking going forward. But just because you made a point that I disagree with doesn’t mean I have to accept that point and incorporate it into my writing. That’s a controlling attitude: accept what I say, or I will reprimand you.

When discussing technical analysis, I cited multiple academic studies and other pieces of evidence. Instead of attempting to refute my evidence or presenting opposing any evidence, Fact Checking simply said “you clearly don't seem to know what you are talking about, so that's the extent I'm going to discuss this topic with you.” That is not what you do when you want to have a real discussion. You don’t just insult someone who disagrees with you and avoid the topic. You don’t have an obligation to respond; you can ignore it or politely disagree and move on, but you should not insult someone.

I think just because Fact Checking is so aggressive and has a better knowledge of accounting than most people on TMC, people just kind of accept what they say. But the loudest, most aggressive, most confident person often isn’t the most knowledgeable one. It seems like Fact Checking is just a beginner like me. Someone who is self-taught and who, like me, makes basic mistakes all the time. Like this:

You make a similar mistake on the GAAP profit side as you made on the free-cash-flow side: you include depreciation & amortization costs while in reality they are out-sized compared to other car companies and related to future growth.

Depreciation is calculated according to the matching principle. That means that depreciation expense begins in the same quarter that the depreciating asset begins to generate revenue. An asset that doesn’t yet generate any revenue doesn’t incur any depreciation expense. If Tesla is using factory equipment to build products that it sells for money, then that factory equipment incurs a depreciation expense. If Tesla is building a new factory in China or a new factory line in the U.S. that isn’t yet making products, then it incurs zero depreciation expense. None.

In other words, depreciation is calculated the opposite way as cap ex. Cap ex is calculated when you invest in future growth. Depreciation is calculated when you start reaping the benefits of that investment. Fact Checking seems to not realize this. It’s something they teach in intro to accounting courses. It’s basic stuff. This is a rookie mistake on Fact Checking’s part.

But, hey, I don’t know what I’m talking about. I got pwned! And GAAP accounting is stupid, anyway!

The only way that depreciation expense can be related to future growth is if 1) the same asset is going to be used to generate more revenue in the future and 2) depreciation is calculated using the straight-line method (i.e. based on time). For most of Tesla’s factory equipment, the straight-line method is used, although the depreciation of tooling is calculated based on units of production. (See Tesla’s 2017 10-K filing. Ctrl+F/Cmd+F “tooling”.) A lot of that equipment is going to start generating more revenue as the production lines are sped up. But I discuss that at length in my article, so that can’t be the point Fact Checking is making (unless they just didn’t read the article).

It’s not bad to make mistakes. That's not my point. Everyone should feel like they’re allowed to make mistakes. Everyone should feel safe to learn and not be embarrassed. It is bad to insult people — whether you’re right and wrong. I don’t care so much if people disagree with me or think I’m wrong (or vice versa). I get angry when people are disrespectful. What does that say about your values? Do you value learning and discussion, or do you value being right and feeling superior to people? I just want everyone to be kind.

This isn’t as directly related to accounting, but it’s another one that’s fairly easy to look up:

ICE incumbents have various liabilities (Diesel-fraud exposure and future liabilities for example) and growth concerns: obviously the ICE engine, which is the central part of their business value, is not a going concern in the long or even medium run and is a significant growth or even shrinkage risk of business. Yet you don't even mention these factors of why the P/E factors of ICE automotive sector are so depressed ...

From what I can tell, this is just empirically not true. If you look at the historical P/E ratios of Toyota, for example, they are about the same now as they were pre-recession.

Look at Honda. Same story. Look at Ford. Same story. Pre-Tesla and post-Model 3, P/E ratios are about the same. There’s no evidence that auto sector P/E ratios are depressed relative to historical norms.

This is why it’s important to do fact checking, and not just believe everything you hear.

Does it count as getting pwned when you say something that’s not true and people just accept it?

Here’s another claim:

Tesla's cash P/E ratio of 9.6x makes Tesla objectively, extremely, mind-bogglingly undervalued even if we exclude all growth premium and ignore the EV market near-vacuum it is expanding into ...

I think this is just incorrect. Let me explain.

“Cash P/E ratio” is a term that’s rarely used. The commonly used terms to mean the same thing are either price/operating cash flow (P/OCF) or cash flow yield. (The terms are interchangeable, but P/OCF is expressed as a multiple of OCF whereas cash flow yield is expressed as a percent of market cap. Just because it’s accounting and we always need to have 3 names for the same thing.)

In my article, I initially computed the value of Tesla using annualized OCF and the average P/OCF of six auto sector peers. I excluded all growth premium. I did exactly what Fact Checking said. On that basis, is Tesla objectively, extremely, mind-bogglingly overvalued? No. The current valuation includes a growth premium. Which should not be surprising. The stock market prices in expectations of future growth.

It would be really weird and shocking if Tesla had no growth premium. The stock market is hyper-focused on computing value using all kinds of metrics, multiples, and forecasts. As a rule of thumb, if anything looks crazily overvalued or undervalued using basic accounting math, you're probably missing something important. Anytime you think there's an obvious mispricing, you're probably wrong. Not always, but almost always.

What if we give Tesla a handicap and use the long-term average P/OCF ratio of the S&P 500, which is 10.6? Once again excluding all growth premium, that gives us a market cap, that gives us a valuation of $59.6 billion. So maybe a little undervalued, but not extremely, mind-bogglingly undervalued. But then again, it isn’t necessarily valid to apply the S&P 500 average for a multiple to any company.

You can always just choose a company with a really high valuation multiple and say your favourite company should be valued on that multiple. But this is not considered good practice. The conventional wisdom is that you should always use the multiples of companies in the same sector or industry. That’s best practice. Sure, you can decide to value Papa John’s at the same P/E ratio as Netflix, but that seems like an ad hoc and arbitrary way to value companies. It isn’t considered good valuation modelling. Professional analysts don’t do it that way, and the stock market doesn’t do it that way.

You can argue that Tesla will one day belong in the software sector because in the future get most of its OCF from selling software or software as a service, but that’s a different conversation — we’re talking about how to value Tesla on its OCF in Q3 2018, excluding all future growth (such as growth in software sales, or any new markets or products). In Q3 2018, the vast majority of Tesla’s OCF came from selling car hardware. So the proper way to value that OCF, excluding all future growth, is to look at the P/OCF ratio of other companies that sell car hardware.

Talking about anything else is moving the goalposts because then you’re either a) using other metrics than OCF or P/OCF or b) talking about future growth, rather than excluding the growth premium. If your claim is that Tesla is extremely, objectively, mind-bogglingly undervalued on a P/OCF ratio basis while excluding all growth premium, your rebuttal can’t be that P/OCF is a bad multiple or that you have to include a growth premium. That’s contradicting yourself.

Tesla's Q3 cash flow includes -$500m growth oriented capex outflow, yet your FCF estimate doesn't account for it

But cap ex isn't subtracted from OCF, and based on OCF and a normal auto sector P/OCF Tesla's valuation is still ~$20 billion. So, this doesn't change the ~$20 billion figure, which is about the same whether you calculate it based on OCF (ignoring cap ex) or free cash flow (subtracting cap ex from OCF).

What the heck, let's throw an extra $2 billion ($500 million per quarter) on top of Tesla's annualized free cash flow. The result you get when you use a normal auto sector free cash flow yield is ~$34 billion. So, no matter how you slice it, there is still a significant growth premium to Tesla's stock. Even if you move the goalposts, it doesn't change the conclusion. Growth is priced in.

This claim doesn’t make sense to me:

You didn't disclose the various limits GAAP metrics have when valuing Tesla

Free cash flow is actually a non-GAAP metric. I used free cash flow prominently in my article.

Every metric has limitations, which is why most people use a variety of GAAP and non-GAAP metrics. I used both GAAP and non-GAAP metrics in my article, and I’m open to any kind of metric anyone suggests. If you don’t like one metric, use another! There are plenty.

I did ask Fact Checking what metric they would prefer, but never got an answer. As I mentioned above, Fact Checking used OCF, which is a GAAP metric.

So ¯\_(ツ)_/¯

Bottom line: don’t believe everything you read on forums (even if the person saying it is very confident and assertive), do fact checking, take a free online intro to accounting course if you’re really interested in this stuff and you’ve got the time (here’s one), don’t be mean, and try to encourage a safe learning environment for everyone where disagreement is okay and mistakes are okay.

 

[strangecosmos]

Brandolini’s law

also Dunning–Kruger effect

and illusion of explanatory depth

 

[strangecosmos]

People are willing to cheer on bullying if it sounds charismatic/confident enough, and if it’s something they want to hear. Even when a quick fact check can show that many of the claims are empirically/objectively false.

 

[Analyst007]

Why don't you make public the exactly same model but including growth estimates? A real discounted cash flow methodology taking into account the industry growth rates for EV's and assuming that Tesla will take around 50% of the market going forward?

Thank you.

 

[strangecosmos]

Why don't you make public the exactly same model but including growth estimates? A real discounted cash flow methodology taking into account the industry growth rates for EV's and assuming that Tesla will take around 50% of the market going forward?

Thank you.

My article is unfortunately now paywalled (not my choice; it happens automatically 10 days after publication), but I did of course also look at future growth. I extrapolated Tesla’s revenue growth rate over the last 3 years to the next 3 years, and assumed cash flow would grow at the same rate. The result was a projected $74 billion in market cap in Q3 2021. I also added a small bit of expected value for autonomy and got a higher number.

I think some people were mad that I was arguing Tesla was not undervalued based on past cash flow (as opposed to projected future cash flow). But for a company to be undervalued based on the past quarter’s cash flow would require the stock market to be really inefficient. I never expected anything else, which is why I didn’t expect people on this forum would be surprised or angry. For me, the finding that only $30-40 billion in future growth is priced in to Tesla’s market cap is positive!

 

[replicant]

My article is unfortunately now paywalled (not my choice; it happens automatically 10 days after publication)

What's the point of publishing stuff there? That's a serious question.

Is it because they pay you something? But in that case, why spend time writing stuff about investing, while you could spend more time researching (or discuss with people who are actually interested in the product, e.g with car owners in the case of Tesla) and make better investments (which would certainly pay much bette than writing for a finance-commentary website)?

Or is it for the audience, but again, since your papers end up paywalled, why chose this website when you could have your own blog and share your article on social media (ad supported or with a patreon)?