Tesla (TSLA) shares rose by nearly 700% in 2020, and the year was capped off by their entry into the S&P 500. The “ludicrous speed” continued into 2021 — where shares went up another 18%.
That means the automaker’s price-to-earnings ratio is an eye-rubbing, nose-bleeding 1,601. For context, the P/E of the S&P 500 is 30, itself, well above the historical average of 15. The next-highest tech valuation in the index belongs to Western Digital (WDC), with a P/E of 860.
All of which is to say Tesla might be a bubble.
Rob Arnott, founder and CEO of giant investment advisor Research Affiliates, certainly thinks so. He spoke to Yahoo Finance about the “heroin-like” monetary and fiscal stimulus that has found its way into stocks, creating bubbles. His prime example is Tesla.
“When you have Tesla trading for more than the entire rest of the auto industry, excluding companies that deal exclusively in electric vehicles… what you’re looking at is an extraordinary spread in valuations,” he said.
First, it’s important to define a bubble, he said. He and colleagues did so in a 2018 article, which he boiled down in an interview:
“One, you’d have to use implausible assumptions in a discounted cash flow model or some similar model for valuation — implausible assumptions to justify today’s price. Part two of the definition — the marginal buyer doesn’t use those tools and doesn’t care about them,” he said. That is, they’re buying because they believe in the story to the exclusion of the numbers.
Of course, there are plenty of Tesla bulls who don’t consider their assumptions to be implausible. One of them is Wedbush analyst Dan Ives, who expects the company’s production to reach 1 million vehicles annually by 2022. Last week, he raised his price target on the stock to $950, with a “bull-case” target of $1,250 a share.
The cornerstone of that case is demand in China, where Tesla on Tuesday began deliveries of its Model Y.
Arnott doesn’t argue that investors need to avoid Tesla, and said he’s using it as an “illustrative example. I don’t mean to single it out. There’s lots of bubbles percolating right now.”
The challenge, he said, is to be prepared for the inevitable burst.
“If you want to buy Tesla, buy Tesla,” Arnott said. “Have an exit strategy. Have a reason in mind in advance for what’s going to cause you to sell.”
Julie Hyman is the co-anchor of Yahoo Finance Live, weekdays 9am-11am ET.