Cast your mind back to the beginning of last month. Had you heard of Tesla (NASDAQ: TSLA)? Were you aware Tesla stock could be bought or sold by individual shareholders?
For me, the answer is yes. I hardly think I am alone. Tesla has been among the most widely discussed shares in recent years, not some unknown minnow lurking in a quiet corner of the stock market.
Yet despite that, the share price of Tesla more than doubled between its low point in January and its high point over the past few days.
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If I had got in at the right time just a few weeks ago, I would already have seen my investment double in value at one point.
I was very familiar with the company last month yet missed out on this phenomenal rally. Why did I not buy Tesla last month?
Ifs, buts and maybes
As an investor, there is no point crying over spilt milk. But our experiences can still teach us valuable lessons for future investment choices.
Just because a share has doubled (or halved) does not mean that one’s initial investment hypothesis was wrong. Jumping in and out of shares on a short-term basis hoping to capture dramatic price swings is speculation not investor.
As a long-term investor, I essentially ask myself two questions when assessing a share as a potential addition to my portfolio.
First, how confident am I that the company will throw off substantial excess cash in future? Secondly, does its current share reflect a sizeable discount to those projected free cash flows, when allowing for the risks involved and also the cost to me of tying my money up in the company?
In other words, I use a discounted cash flow method of valuation.
Why I didn’t buy Tesla
Although I use that method, other investors may not. They may see the value of Tesla (or any company) very differently to me. That is what makes it a stock market. On top of that, a lot of speculators in the market trade Tesla stock and that can also influence its price, sometimes dramatically.
I did not buy into Tesla at the start of the year was because I did not think it merited its valuation then. The share price has roughly doubled meanwhile but I do not think the carmaker’s prospects have improved dramatically during that period. So I think it is even more overvalued now.
Great company, unattractive price
I actually think Tesla is a very promising company with a potentially bright future ahead of it.
But liking Tesla as a business and thinking it merits its current market capitalisation of $650bn are two different things. Last year Tesla generated free cash flow of $7.6bn. It has been cutting pricing as the electric market vehicle becomes more competitive. That could eat into profit margins.
I expect continued strong revenue growth from the company. It has significant competitive advantages, from its distinctive brand to a large installed customer base. That could help it increase free cash flows in future.
But the risks are sizeable and I think Tesla stock is priced for perfection. Accordingly, I still have no plans to add Tesla to my portfolio.
