A deep dive into why Tesla shares have soared

At face value there is no good reason for the doubling in the Tesla share price seen so far this year. Look a little closer, however, and the reason becomes clearer.

Article updated: 6 February 2020 10:00am Author: Michael Baxter

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The Tesla share price increased from $418 on the last day of 2018 to $887 last night. Back on June 3rd 2019, Tesla shares were at a mere $179. If you had bought into the company on that day you would have almost increased your money five-fold.

This column has long been decidedly bullish about Tesla, and for several reasons.

Here is why:

  • Firstly, and perhaps most important of all, in addition to making cars, Tesla specialises in lithium ion batteries. It is the world leader is this field and that's important. Tesla is a classic example of a disruptor in the late Clayton Christensen’s innovator dilemma theory. While other car companies, often after canvassing the views of their customers, dismissed the threat posed by electric cars, and in any case considered there was no benefit in making lithium ion batteries inhouse, Tesla got hard to work. Now, Tesla has this huge lead over other companies because of its specialty in battery production.
  • For electric cars, the battery is the most complex part of the manufacturing. Making a car is complex. When Tesla projected that it would soon be making 5,000 cars a week, car industry veterans reacted in disbelief. But electric cars have less moving parts than traditional cars. The target was achievable for that reason, all that Tesla had to do was crack the problem of making batteries, a task for which it is the world leader.
  • Tesla batteries are made for other purposes too, such as energy storage for the grid and to work alongside solar panels, which it also makes. This gives Tesla economies of scale in battery manufacturing that no other company can match.
  • Then there is the point about exponential. Lithium ion batteries are falling in cost at exponential rate –– around 80 per cent cheaper today than in 2010. It is human nature to underestimate the significance of exponential change. If the batteries continue to fall in cost, at the same rate they have witnessed over the last decade, then by 2030 the economics of owning an electric car over an internal combustion engine car will be overwhelming. This, by the way, is the point that critics of the UK government’s plans to legislate for all new cars being electric by 2035, don’t get. By 2035, nearly all new cars will be electric anyway –– why buy a petrol car when an electric car will be so much cheaper over its lifetime? This will be the case by 2035, because of the exponentially falling cost of batteries.
  • Tesla is also an AI company – one of the leading AI companies in the world. PwC has projected that AI will contribute $15.7 trillion to the global economy in the year 2030. AI will be especially important in the area of autonomous cars and sharing cars. In this field, Tesla’s expertise is right up there with Google’s.
  • Oh yes, don’t forget climate change. Tesla cynics say that the process of making lithium ion batters is carbon expensive, but they ignore the effect of exponential –– the carbon cost is falling, and at an exponential rate.

Now let’s take a look at the company’s latest results. At face value they're nothing special. Revenue increased by a tiny one per cent in Q4 2019 compared to the same quarter in 2018. Net income attributable to shareholders (profit) was $105 million, but in Q4 2019 it was $140 million. You could be forgiven for asking what is so special about the results?

The numbers

These two charts look at quarterly net profits at Tesla since Q1 2017 and annual profits since 2016.

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Sure, you can see there is a positive trend. Perhaps the only really big improvement in 2019 compared to 2018 was that the loss in Q2 was significantly less.

Look deeper, however, and things start to appear more impressive.

Two factors mitigated against Tesla revenue and profits in 2019 –– sales of the Tesla 3 increased, but sales of the Tesla S/X fell. The Tesla 3 is much cheaper than the S/X, therefore revenue and profits per car were less. There was also a big increase in the automotive leasing. Revenue from leasing is counted as monthly payment, so the revenue per car which is leased tends to stretch out over a longer time frame.

Tesla says: “We do not expect average selling price to change significantly in the near term.”

Look at car production, and things appear altogether more promising.

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Bear in mind, that when Tesla first achieved its target of 5,000 units a week, critics said that this was achieved only by making a big loss per car. It is now making something like 8,000 cars a week, and the fact that it is has been profitable in four out of the last eight quarters, and the fact that its last quarterly loss was significantly less than the loss in the same period in the previous year, seems to suggest these critics were decidedly wrong.

The future

So, what next?

There are several reasons why the markets have bought Tesla shares in such quantities, and the above numbers merely provide a reassuring backdrop.

For one thing, Panasonic, Tesla’ partner in its Gigafactory in Nevada, has said that the factory has just turned a profit

Then there was news a few weeks ago that Tesla had filed patent for a battery that can last one million miles I can’t over-state how significant this could be. A battery that lasts a million miles would extend the lifetime of electric cars – which, to reiterate from above, have less moving parts than traditional cars, and so battery aside, should last much longer. This lifetime extension will be significant and reduces the cost per mile of running a car and dramatically reduces carbon emission during the lifetime of the car.

Finally, there is a view that Tesla is set to enjoy economies of scale such that it is close to seeing a productivity revolution. For example, Ryan Guttridge from Clockwise Capital has suggested that the current situation at Tesla is analogous to manufacturing in 1910. The railroad boom created a concentration of manufacturing leading to assembly line production and massive productivity advances. He argues that technologies such as 3D printing, AI and the cloud will create a similar revolution and Tesla is perfectly positioned.

Personally, I think Tesla’s real long-term advantage lies with its growing expertise in autonomous cars and its plans in car sharing.

Can shares carry on rising?

Certainly Tesla shares are at dizzy heights, and even a Tesla bull like me feels they are probably going to fall soon.

Long-term, however, this company has an awful lot going for it. Furthermore, I am not sure it is commonly understood, how much it has going for it.

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These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees

Michael Baxter portrait photo
Michael Baxter

Economics Commentator

Michael is an economics, investment and technology writer, known for his entertaining style. He has previously been a full-time investor, founder of a technology company which was floated on the NASDAQ, and a director of a PR company specialising in IT.

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