In Chapter 13 of The Intelligent Investor, Ben Graham compares four companies to show the differences in valuation that can occur in the stock market while also illustrating a few simple investing principles.
Let’s perform a similar exercise by comparing ‘old economy’ General Motors (NYSE:GM) and electric car manufacturer Tesla Motors (NASDAQ:TSLA). Both companies are in the automobile business, with Tesla also buying solar power firm SolarCity late in calendar 2016.
Before we do so, however, please note that I’m going to ignore any metrics involving enterprise value as they are inappropriate for banks and financial companies due to the large amounts of debt they use. As GM’s large captive finance division distorts enterprise-value based metrics, I’m going to keep things simple and just concentrate on equity-based metrics.
|Gross income ($m)||21,805||2,015|
|Tangible book value ($m)||39,779||4,558|
|Share price at 11 Jul 17 ($)||35.40||327.22|
|Market cap ($m)||55,153||49,607|
|Gross margin (%)||12.8||23.6|
|EBIT margin (%)||6.1||(7.4)|
|Net margin (%)||5.9||(8.5)|
|Div yield (%)||4.3%||n/a|
|Note: amounts are in US dollars and are at 31 March 2017 unless noted|
As you can see in Table 1, General Motors’ market capitalisation of US$55bn is only 11% more than Tesla’s.
Let’s assume you have a spare US$55bn and are trying to decide between purchasing all of General Motors or all of Tesla (again, I’m ignoring debt to keep the comparison simple).
If you choose General Motors, you get a company that sold 6.4m vehicles in calendar 2016 plus 2m more in its Chinese joint ventures. By contrast, Tesla only sold 84,000 cars in 2016.
This is why General Motors’ 2016 revenue of US$170bn is around 20 times greater than Tesla.
Even so, Tesla generates gross margins around twice those of General Motors due to its business still primarily being in the luxury car space. Although these gross margins will likely fall as Tesla cranks up production of its more reasonably priced Model 3.
After taking into account selling, general and administrative costs, General Motors earned US$10bn in operating income in 2016 compared to a $723m operating loss for Tesla.
The auto industry is very capital intensive and so tangible book value is another relevant metric: you'd pay around 1.4 times tangible book when buying General Motors compared to an eye-watering 11 times tangible book for Tesla. This is despite General Motors earning a very respectable return on tangible book value (ROTBV) of 25% while Tesla’s ROTBV is of course negative.
Finally, you’d be paying around five to six times GM’s 2016 earnings – the lowest PER in the S&P 500 – while receiving a 4.3% dividend yield (high for a US-listed company) and also benefitting from billions in stock repurchases.
By contrast, Tesla doesn’t have any earnings – yet – and is retaining all its capital while likely requiring more to keep growing.
Why the valuation differences?
So despite the vast difference in revenues and profitability, it’s clear that investors currently prefer Tesla over General Motors.
As is often the case in the stock market, though, there are some good reasons for this.
Not least due to government policies, fossil fuels – and by extension anything that uses them such as cars and trucks – are in decline while renewable energy such as solar and wind are on the rise.
General Motors is generally perceived as a vendor of gas-guzzling cars and trucks while Tesla is known as the electric vehicle pioneer. When consumers think electric cars, most think of Tesla, showing it has built a valuable brand in a short time. And whatever the reason for the SolarCity acquisition, this has only increased Tesla’s clean energy reputation.
In terms of growth, Tesla’s vastly inferior current production is actually a good thing: its far easier to exponentionally grow vehicle production from a base of 84,000 than from 6.4m. Tesla should be helped in this regard by the impending release of its new Model 3, more reasonably priced than its previous models at US$35,000.
Another possible explanation is the threat of driverless cars. If they do in fact take over our roads in the near future, it’s likely driverless cars will dramatically reduce the demand for vehicles as many consumers prefer to ride share rather than own cars outright. This of course poses a great threat to General Motors – especially given its high fixed cost base and low margins – but less so to Tesla given their respective production levels.
And maybe there are other explanations that I haven’t considered.
In the price
In any case, it’s important to note that the stock market is an anticipatory system, where stock prices represent the consensus expectations of investors at any point in time.
As such, I think Tesla’s possibly much brighter future than General Motors is more than reflected in both company’s share prices, especially as every major car manufacturer including General Motors has released or will shortly release reasonably priced electric vehicles. Investors seem to think that nothing will ever go wrong with Tesla and that it will soon grow into its expensive valuation, while General Motors is being priced as if it will be out of business within a decade.
So, if I was forced to choose, I’d be more interested in buying General Motors than Tesla. But what do readers think?