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Michael Farr says Tesla is too risky a bet for most investors

Tesla’s stock is stupidly expensive. It may go higher and shareholders may be rewarded, or it may languish or fall.

There is no law prohibiting stupidly expensive from becoming moronically expensive. Moreover, speculative companies that actually achieve explosive sales and profit growth for a number of years can actually make outlandish valuations seem justified for a time.

The problem comes when fantastic expectations disappoint and worried shareholders look down to discover the thinnest of thin air beneath them.

Shares of the electric automobile maker were added to the S&P 500 Index last week and struggled. But they are still up an astounding 690% this year and now has a market value of nearly $617 billion.

The current valuation makes Tesla the sixth-largest company in the S&P 500, and by any metric, shares of this company are expensive.

The price-to-earnings multiple for the overall S&P 500 is currently about 22.3 times the consensus earnings estimate for 2021. Tesla shares are trading at more than 168 times.

It is true that TSLA’s earnings are projected to grow at a rapid pace over the next several years, but shares are still priced at 77 times the consensus 2024 estimate. If that sounds expensive, take a look at price-to-sales multiples. The average price-to-sales ratio for the S&P 500 is 2.7x while Tesla is at over 13x!

What could go wrong

A few hot-concept momentum stocks actually do pan out and become fabulous long-term investments.

But many more do not, and the high-profile success stories that are Apple and Amazon and Microsoft can cause investors to rationalize their decisions to follow the herd, ignore valuations, and effectively throw caution to the wind.

Share prices have soared, but is this a fabulous investment opportunity at a market valuation of $616 billion?

The company is now worth more than double the combined market valuations of Ford, GM and Toyota! Could it someday be worth triple? Maybe.

One thing is sure to happen though; whichever path prices follow — up or down — choruses of Wall Street wags will sing the “Of course I knew it” hymn. History is annoyingly obvious once it becomes history.

Think before you buy

Considering buying Tesla shares? Two points: all else equal, when you buy stocks at high valuations, your expected future returns are going to fall.

Second point: all high-growth companies begin trading in anticipation of huge future growth.

When that growth successfully materializes, as it has for companies like Amazon, Facebook, etc. all is well. But for each Amazon and Facebook there are a slew of companies that struggle just to survive their first economic downturn.

The point is that in order to build a company as successful and Amazon, Microsoft and Tesla, fabulous ideas and impeccable execution need to be combined with good fortune and excellent timing.

The late 1990s dot-com bonanza was rife with spectacular, sparkling companies never heard of before nor heard from since. But they didn’t make it to Tesla status.

Why Tesla is not special

My friend Jim Cramer recently opined on CNBC that Tesla deserves a halo that other companies just don’t deserve.

Jim said that, “Tesla is the stock that broke how we view stocks. It’s a totally unconventional way to look at stocks, and younger people look at a company that can make a battery and they dream dreams. They don’t go with the spreadsheet. They see things that we don’t see.” But, dreams don’t survive very long without spreadsheets.

As my buddy, Seabreeze Partners’ Doug Kass opines, “Tesla has a shallow moat. Adjusted for the sale of emission credits, Tesla has never been profitable in its 17 years of existence (despite having no competition and no need for advertising.)”

The trailblazer for concept alchemy is Amazon. Amazon was the nascent online bookseller in the 1990s that persuaded Wall Street that earnings didn’t matter.

As long as the concept continued to make sense and top-line growth was strong, Bezos was free to build a behemoth retailer not burdened by pesky things like profits or cash flow. It was a snow job worthy of P.T. Barnum, and it worked. Amazon shares soared, though positive earnings were 15 years into the future, and then only because of a completely different business line (cloud storage).

But for every Amazon there are hundreds of momentary darlings like JDS Uniphase and In the early moments of concept-driven rapture and the extrapolation of high growth rates many years into the future, all things are possible.

Dreams are why people play the lottery, and lottery results are why states run them and generate millions in revenues.

A rough gamble

Tesla has already been a fabulous success for investors, and it could work out as a great long-term stock someday. But when stocks become this expensive, there is far, far less margin for error.

Tesla at these levels is more dependent on momentum investing and the “greater fool” theory than anything else right now. It is much too speculative for investors like us.

If someone knowingly wants to roll dice, Tesla could work.

My longstanding advice to gamblers is go to Las Vegas! At least when you lose in Vegas, they’ll comp you a free cocktail.

For most folks, money is hard to make and harder to save. Disciplined, dispassionate investing builds wealth over time. Farr’s advice is to leave gambling to gamblers and focus on becoming a better investor. Happy holidays!

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