The Buy Scan | July 5, 2023

Published on 07/05/23 | Saurav Sen | 1,843 Words

The BuyGist:

  • We send out The Buy Scan at least once a week.
  • We cover the most pertinent (and trending) topics in investing.
  • We rely heavily on our primary valuation tool - The Buycaster - to get actionable insights.
  • We hope that each Buy Scan provides at least one salient insight.

The BuyChart of the day: Is TSLA a good buy?

Tesla reported some blockbuster numbers this week. It seems that their aggressive price cuts boosted car sales in Q2 by a whopping 83% year-on-year, thereby more than offsetting the effect of Elon Musk’s Twitter shenanigans. For context, in Q1 that growth number was about 36%. Is this latest report on number of cars sold a harbinger of more things to come? TSLA bulls must believe it. We’re skeptical.

To answer the question, we believe buying TSLA is a risky bet. So, no thanks. On the other hand, unfortunately, every time we dig into Tesla, we come out skittish. And it sucks because the market keeps punishing us for missing out. But we take solace in committing a (potential) mistake of omission rather than commission. We can sleep well at night with that. What would really yank our chains would be buying something because of FOMO, and then watching the stock tank because one day Mr. Market suddenly wakes up of rational side of the bed. There is no way to time that.

The growth expectations baked into TSLA are hard to digest. More specifically, for us, revenue growth expectations that we need to believe to consider buying the stock look, frankly, ludicrous. Here’s TSLA’s Buycast from our Buycaster:

This is the explanation of the chart (pasted straight from The Buycaster):

TSLA has a LOW SANITY Rating because it is DIFFICULT to believe THE BUYCAST of 57.9% – our measure of ‘what we need to believe about the business to consider buying TSLA today’. The BUYCAST is measured in terms of future Annualized Revenue Growth (ARG). So, to consider buying TSLA, we need to believe that Tesla Inc.'s revenue will grow at an average of about 57.9% per year for the next 5 years. This looks like an irrationally exuberant scenario.

To be specific, The Buycast is our estimate of “revenue growth in the underlying business that we need to believe to RATIONALLY expect a stock to deliver 80% cumulative return in 5 years (12.5% CAGR)”. The Buycast is the crux of, well, The Buycaster. This is a back-solving process – we back-solve from the “desired stock price” (what we want) to the “revenue growth that needs to happen” while make some reasonable assumptions along the way as we move the cash flow waterfall (details and mechanics in the Appendix). We call this process “Buycasting” – we’re not forecasting, we’re Buycasting. The key question, however, is “is The Buycast believable?” So, we compare The Buycast to not just to the past historical revenue growth numbers but also Wall Street expectations of future revenue growth (which we consider with a grain of salt), and some industry-specific adjustments on our part. Once we take all that into account, we apply a 20% margin of safety discount (in most cases) to be more conservative. And so, we get to the second-most important variable in this dashboard: THE DOWNCAST – this is our estimate of a realistic low-growth scenario. The difference between The Buycast and The Downcast is the basis of the SANITY Rating The bigger the difference, the less believable our Buycast is, and so, lower the SANITY Rating; and vice versa.

TSLA's DOWNCAST is 25.5%, which is uncomfortably low compared to its BUYCAST of 57.9%. The gap between 'what we need to believe' and 'what could happen in a pessimistic growth scenario' is uncomfortably large, which drags down the SANITY Rating. The Downcast is dragged down primarily by relatively low recent revenue growth [compared to the Buycast]. This Downcast is, in fact, the link between SANITY and SAFETY. Now we're moving into RISK territory. Cue in the SAFETY RATING. 

----End of Buycaster Explanation---

But wait…hold your horsepowers! Maybe this 57.9% Buycast isn’t that ludicrous after all! Cue in The BuyTheme of the day.

The BuyTheme of the day: Investing in Autonomous & Electric Vehicles

Bloomberg New Energy Finance (BNEF) does some great research. Their latest EV issue had some encouraging numbers:

Tesla has been a primary recipient of this trend. No, that’s not giving the company enough credit – we could easily argue that Tesla spearheaded this trend. But we digress. The question in our mind is: is the Buycast of 57.9% believable? That BNEF EV issue had some other stats that will help us answer this burning electric question.

Let’s start with some non-controversial facts and assumptions (inspired by the BNEF report):

  1. The number of passenger cars sold across the world won’t grow by much. We’ll assume they grow by about 2% annually, which is quite generous given the anemic trend over the last decade.
  2. Of that 73 million, about 10.2 million were EVs in 2022 according to BNEF. But remember, that 10.2 million includes hybrids.
  3. Tesla sold about 1.3 million cars in 2022. That’s about 13% of the total number of EVs sold (again, the denominator includes hybrids). Tesla’s share of fully-electric cars is probably much higher, but we couldn’t find a reliable source for that yet. More on this in a minute.
  4. Let’s assume that Tesla’s average selling price (of its cars) remains at the 2022 average level. So, in this little exercise, we only need to worry about Volume. By the way, this is a generous assumption – Tesla found the need to cut prices to boost sales in 2023. We expect competition to keep forcing Tesla’s hand on prices, especially in Europe and Asia.

Now let’s deal with the somewhat controversial assumptions:

  1. What will Tesla’s market share be when 100% of passenger car sales are fully electric?
  2. When will the world buy only electric cars? 2025? 2030? 2050?

We’ll need to play around with the controversial assumptions. Yes, we did. Here’s how Tesla’s revenue growth numbers came out of the oven:

Not so encouraging. To be clear, there’s a 3rd controversial assumption that we haven’t touched: Tesla’s cost structure. In The Buycaster, we do assume cost structure changes, but we’re reasonable:

  1. We assume that Gross Margins (representing variable costs) does not change.
  2. We assume some economies of scale in Fixed Operating Costs and Capital Expenditure.

In Tesla’s case, one could argue that its cost structure and margins will improve over the next 10 years. If that’s the case, there is some conservatism built into the matrix above. Even so…

What do you think? Do you buy the “60% market share in 2030” scenario? Maybe with some cost improvements, it will come down to a 40% market share in 2030? Do you buy that scenario? To us, TSLA’s price is too high to buy, if we want to sleep well at night, which we do.

Remember that the volks at Volkswagen (and Toyota, Ford, Mercedes, Honda etc.) are not sitting around twiddling their thumbs. They may be late to the party, but they’re here now. Competition for Tesla will inevitably increase. And we’re not sure that some sort of Tesla software domination will lead to total EV domination. Well, YMMV.

Macro Dose: US Stocks - so much winning!

The latest Economist issue had a little article about how Americans mostly buy American stocks. Patriotism, as they noted, is not the main reason. A big part of it is trend following – even financial pros like momentum. That tendency has paid off. We were curious, so we plotted the growth of a $1,000 over the last 20 years, comparing this buy-and-hold hypothetical investment in the MSCI All Country World Index (ACWI) vs. the MSCI ACWO + Frontier Markets excluding USA. The first one – MSCI ACWI includes USA – and it wins!

The statistical argument is fine. But it’s a weak one. The qualitative, touchy-feely arguments make more sense. You’ll notice that the outperformance of the US-heavy index started sometime in 2015. Coincidentally (we think not) that was the beginning of the “new tech rally”, which is AI-and-software-powered. We think this out-performance still has legs because high-tech and software companies can build a wider moat around their competitive advantage, faster.

The other touchy-feely argument for not having the need to diversify internationally is that the largest US companies are global companies anyway, with much (if not most) of their revenues coming from non-US markets. So, what’s the point of taking on that bad-corporate-governance risk, where you can’t really trust the numbers of some frontier market public company that promises to have finally found El Dorado? That’s asking for Low Return, High Stress. That’s the opposite of what we’re shooting for.

For reference, about 30% of our portfolio is non-US. But that was not planned in some black-box asset allocation model. It is purely a result of us finding the best companies with most durable competitive advantages. And overall that bet has helped us beat the S&P 500 over the last 5 years.

Note: We’re not Macro investors, nor do we indulge in Commodities, Currencies or Cryptos. However, we like to keep an eye on possible overreactions in the equity markets due to macro factors, so we can be greedy when others are fearful, and vice versa.

We wish you many Happy Returns!

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