Predicting the future is hard enough as it is, but if you’re doing it for a well-established, large company, then your task is significantly easier. The past will be a fairly decent predictor of the future (except when it’s not). But what about when the past is volatile, and the future is uncertain? That’s the problem analysts are having with valuing Tesla, but this is not a new problem. It’s been around for at least 14 years (give or take):
Just as investors today argue over whether Tesla is more Detroit or Silicon Valley, it was hard back in 1999 to decide if online retailer Amazon.com represented a genuinely new paradigm or just a different way of shifting merchandise. That makes valuation trickier than usual. [link ($)]
The valuation technique is discounted cash flows (DCF) where they discount back to the present, some future estimate of a company’s estimated cash flows. Sound familiar? It should, because that is exactly what you guys are doing for your projects.
For Amazon, Citibank first took the plunge in April 1999, and posted a buy rating for them. The caveat? About 94% of Amazon’s valuation came from cash flows that were at least 10 years out! The reality was quite different:
For virtually all of the 10 years following April 1999, Amazon’s stock lagged the S&P 500 and at one point had lost more than 90% of its value.
As the article continues to point out, even today almost all of Amazon’s value comes from cash flows that are expected in 2020 or beyond. DCF valuation, especially when the future value is so far out is tricky business. As the article points out:
…long-dated valuations are inherently risky. Imagine an archer aiming at a far-off target: Pointing the arrow even a couple of degrees to the right or left can mean missing wildly.
Small changes in variables like the discount rate, which accounts for the time value of money and risks involved, have big effects.
Now what about Tesla? Their valuation is no different, because they are placed in a somewhat similar space as Amazon was back in 1999:
When J.P. Morgan Chase raised its target price for Tesla in August, 86% of the discounted-cash-flow valuation related to 2020 and beyond. The same figure for a model published last month by Deutsche Bank was 87%. By way of comparison, in a recent Deutsche model for General Motors, only 50% of the valuation was derived from projections past 2019.
So what can we do? Well, not much. But as the article says:
The point isn’t to poke fun at long-term assumptions that don’t pan out—they almost never do. There can be no denying Tesla’s success to date and the plaudits its vehicles have garnered. But by 2023, everything from gasoline prices to the competing line-ups of bigger rivals, and much else in between, will have changed in ways it is impossible to imagine today.
With so many unforeseen and potentially treacherous twists on the road ahead, it is risky to simply put the pedal to the metal and hope for the best.
You can only imagine the problems analysts are having with Twitter…