Over the last five years, the Tesla (NASDAQ:TSLA) share price has gone from just under $20 to $265 (adjusting for stock splits). That’s a staggering increase of 1,230%, or 67% per year.
There’s no two ways about it – the stock has outperformed every major index and continues to defy its critics. But why has the share price gone up so much and how can investors find the next Tesla?
Why do stocks go up?
In general, there are three reasons that stocks go up. These are improved profitability, higher shareholder returns, and investor optimism.
Improved profitability can come about in a couple of different ways. One is by increasing revenues and the other is by reducing costs, causing margins to expand.
Higher shareholder returns can come via dividends paid directly to investors or share buybacks that increase a shareholder’s ownership of the overall business. Both increase the value of a company’s shares.
Investor optimism involves the stock market being willing to buy a company’s shares at a higher multiple of its net assets. This is usually due to positive expectations about the business going forward.
Each of these are reasons that stocks can go up. So which of these explains the market-beating performance of Tesla shares over the last five years?
Tesla’s market-beating returns
A lot of the performance of the Tesla share price is the result of growth in the underlying business. Back in 2018, the business generated $21.4bn in sales and managed a gross margin of just under 19%.
In 2022, the company achieved revenues of $81.5bn and managed a gross margin of 25.6%. In other words, the firm managed to both increase the amount it generates through sales and improve its efficiency.
As a result, gross profits increased from $4bn to just under $21bn over the last five years – an average of 39% per year. So what accounts for the rest of the stock’s 67% annual growth?
Since the business hasn’t paid a dividend and its share count has gone from 2,559 to 3,475 over the last five years, it isn’t shareholder returns. Instead, it’s multiple expansion driven by investor optimism.
Five years ago, Tesla shares traded at a price-to-sales (P/S) multiple of 2.38, with $21.4bn in revenues and a $51bn market cap. Today, the implied multiple is 10.32, with $81.5bn in revenues and a $841bn market cap.
Finding the next Tesla
There’s no question that the growth in Tesla’s share price is down to two things – business results and investor optimism. But I think one of these is more important than the other.
As Warren Buffett points out, stocks tend to perform in line with the underlying company over the long term. So I’d focus on finding a business with great prospects, rather than predicting investor sentiment.
A company’s share price might not always reflect how the underlying firm is doing in the short term. But this usually corrects itself over time in the stock market.
That’s why I’d concentrate on looking for a business with good growth prospects. This isn’t entirely straightforward, but getting this right usually means the rest will follow.
