Why Tesla's up 500% This Year

At Janus Henderson Investors, we believe working together is the way to work better. Like combining your portfolio plans and our in-depth strategy. Your valued assets and our valuable insights. Your vision and our mission. Working in harmony to seek the right investment opportunities. Janus Henderson Investors. Investing in a brighter future together.

For some, it's a disconnect because I think some investors scratch their heads when they look at where Tesla's valued. But you cannot, in my opinion, you can't value like a traditional automaker. It's more of a technology player.

Welcome to the Barron Streetwise Podcast. My name is Jack Howe, and the voice you just heard, that's Dan Ives. He's an analyst at Wedbush covering, among other things, Tesla, the carmaker. Dan and others say that Tesla's shocking 500% stock gain this year makes sense. We'll hear why. And if you don't own Tesla stock, you might soon, because by Christmas it will be added to all of those index funds that track the S&P 500. We'll also say a few words about the outlook for casual dining chains. I'll buzz you when your table's ready. Geez, I can't believe the calorie count on these jalapeño poppers. I mean, I was gonna— oh, listening in is our audio producer Meta. Hi, Meta.

Hi, Jack.

Meta, it's a short work week. We are recording this just before Thanksgiving, but people will be hearing it just after Thanksgiving, how do you imagine that future Metta would tell me that her Thanksgiving dinner went?

I think she'll say it was very nice. The lentil nut vegan meatloaf was very moist.

Oh man.

And seeing the family on Zoom was very lovely.

That's nice.

And there will be stuffing, so all is good.

I'm happy for you, Metta, but I have to talk about something sad now. Because two things have happened in recent days that I think sum up the bizarre mix of real-world gloom and financial world euphoria that we've seen for months now. For the first time since May, we've started to see days with more than 2,000 reported U.S. deaths from COVID-19. But also on Tuesday before Thanksgiving, the Dow Jones Industrial Average topped 30,000 for the first time. And we've talked about this contrast before. I think the most important force in the financial universe for more than a decade now has been ultra-low interest rates. If the economy looks wobbly because the virus is raging again, that makes policymakers all the more likely to keep interest rates near zero, which leaves bond yields looking pitiful and shifts investor attention towards stocks even if stock prices are higher than usual. In that sense, bad news for the economy can sometimes be good news for stocks. But good news can be good news too, and there is important good news in the form of multiple vaccines now that appear highly effective in trials and likely to be widely administered, maybe beginning before the end of this year. And that means we can start getting back to normal next year which would obviously be good for company earnings. Goldman Sachs estimates that earnings underlying the S&P 500 index will jump 29% next year. And I know they're rising from depressed levels, so a big increase is expected, but Goldman's 2021 earnings estimate is also 6% higher than the record earnings we saw before the pandemic in 2019. So that would clearly be welcome news for stock investors. But it's a strange situation to have stocks rising on bad news and good news at the same time. I think it leaves some investors looking for signs of bubbly pricing. If Goldman is right in its forecast, then the S&P 500 trades at 21 times next year's earnings. That's definitely high, but it's not bonkers. And gains for stocks in the index have been unevenly distributed. Goldman recently calculated that with the index up 12% for the year, 5 tech giants in the index— Apple, Microsoft, Amazon, Alphabet, and Facebook— were up 49% for the year, and the rest of the index was up just 5%. Even if those tech giants stall, so long as beaten-down stocks like airlines recover, Goldman figures the S&P 500 can eke out a decent return next year. Now some assets do look bubbly. I've called Bitcoin, the cryptocurrency, a good proxy for speculative excess. It doesn't have any earnings or dividends or close links to the real economy. So when its price goes nuts, it makes me wonder if investors are getting ahead of themselves. Bitcoin has now doubled in price since summer and it's close to an all-time high. And I hear plenty of Bitcoin bulls speculating that from here it'll multiply wildly in price to hundreds of thousands of dollars. It seems ridiculous, but not much more ridiculous than Bitcoin trading recently at around $20,000, up from a fraction of a penny about a decade ago. And that brings us to Tesla. It's nowhere near as dismissible as Bitcoin. Car making is closely tied to the real economy. And Tesla's recent business momentum is undeniable. We're watching shares of Tesla this morning, and frankly, when are we not? The stock is up 5% premarket right now. That follows a 6.5% gain during yesterday's session. Based on this morning's—

Silicon Valley innovator reaching new heights with Tesla's market value crossing $500 billion. That allows him to zoom past Bill Gates and snag the title of the world's second richest person.

Gosh, it's, it's hard to see who's going to catch Tesla.

You've got the S&P inclusion, you've got, you know, everything hitting on all cylinders for Tesla from a sales perspective. This year its revenues are expected to rise 25% to over $30 billion, and that's during a year when the pandemic disrupted manufacturing. Next year revenues are expected to jump 40%. Tesla is projected to turn a profit this year and every year for the foreseeable future. The company seems to have a big lead in electric vehicles against much more established players. Earlier this month, General Motors says it was increasing its spending plans for electric vehicles over the next 5 years from $20 billion to $27 billion and introducing more new electric models than it had previously planned. Why? Well, I saw one Wall Street forecast that said that General Motors might sell 1 million electric vehicles a year by 2030. I know that sounds like a lot, but Tesla is now expected to reach 1 million vehicles a year by 2022. That would give it an 8-year lead over GM. Suddenly GM has a lot of catching up to do. That's just electric vehicles, of course. Overall, GM's revenues are about 4 times the size of Tesla's, and its profits are much higher. So it was a shock in October of last year when Tesla reached a stock market value of $53 billion, passing GM to become the most valuable U.S. carmaker. Plenty of people asked at the time whether Tesla had gotten ahead of itself. What has happened since then is far more remarkable. GM's market value was increased. It's up to about $66 billion, but Tesla's has multiplied to $526 billion. How big is that? It's close to the value of Warren Buffett's investment conglomerate Berkshire Hathaway. If Tesla passes that, which it could any day, it will be the 6th largest company in America. Only the 5 tech companies I mentioned earlier are larger, Apple, Microsoft, Amazon, Alphabet, and Facebook. If you don't own shares of Tesla, you might nonetheless have a stake in what happens next. That's because the company that oversees the S&P 500 index recently announced that it will add Tesla to the index by Christmas. It might have to add it in pieces because the company is so large. Now, there's about $12 trillion in investment assets linked to the S&P 500 in index funds and the like. Future returns for all that money will depend, at least a little bit, on whether Tesla stock can climb higher or whether it has gotten too expensive. To learn more about that, I reached out to an analyst who covers the stock, Dan Ives at Wedbush.

How's everything, man?

Going well. How you doing?

Good, good, man. Good.

Hang on a second. Meta?

Yep.

Dan asking me how I'm doing reminds me of something I read on a travel website. It said some lovely things about your home country of Denmark, but it also had a tip for Americans. I want you to tell me whether it's true. All right.

Okay.

It said we should avoid using the greeting, "How are you?" But the article said that Danes regard it as a bit of a joke that Americans say, "How you doing?" when they have no intention of stopping and taking the time to learn how someone actually is. Is there truth to that?

There definitely is.

Oh no, no.

But I actually now enjoy the how are you doing and use it a lot myself. So you can find the value in how are you doing.

Yeah. By the way, matter, how are you? And I mean that sincerely. I want you to take all the time you want now to tell me.

Well, Jack, I have a bunion that's bothering me and I'm going to tell you all about it. It starts with me going to the pharmacy.

You know what? I want to hear this, but we better get back to Tesla and you can tell me about it later.

The Danes were right all along.

You don't want to hear the truth. I noticed that Dan this past Tuesday raised his price target on Tesla from $500 to $560. And the stock jumped 6% and closed near his target. Dan also raised his bull case price target from $800 a share to $1,000 a share. That's something I see a lot of analysts doing lately, publishing not just one price target but three—base, bull, and bear cases—for if things go like they expect or worse or better. Anyhow, That bull case suggests a lot more upside potential for Tesla, and I wanted to hear where it might come from. I asked Dan, what are the biggest things that have been going right for Tesla? He says the main thing is that demand for EVs, or electric vehicles, in China is on the verge of taking off.

That's potentially 40% of demand by 2022. I think that could be another $100 to the stock in terms of what that ultimately adds in terms of that China story.

And that's a big part of our bull case Tesla does a lot of manufacturing in Fremont, California, but it has also built 3 of what it calls Gigafactories. Giga Nevada makes batteries and other components. There's Giga New York in Buffalo that makes solar roof tiles. And its newest factory is in China. It's called Giga Shanghai, and by next year it's expected to be able to turn out 500,000 vehicles a year. With production focused on Tesla's two newest models: the Model 3 sedan starting around $38,000 and the Model Y midsize sport utility vehicle starting at about $50,000. There are more Gigafactories planned, including one in Berlin to serve Europe and one in the central United States to make Tesla pickup trucks called Cybertrucks. Dan says Tesla's momentum extends well beyond China. Electric vehicle demand looks likely to accelerate worldwide.

We're going into a golden age of EV demand, and I think we can get from 3% of vehicles today to 10% that will be EV by 2025. And I think the difference is that it's across all price points and it's across all models, especially as we go into next year with pickups and other different categories.

Dan says Tesla also stands to benefit from governments pushing to reduce carbon footprints, especially in Europe. So okay, Tesla's well positioned, but the stock has climbed so high that Tesla isn't just worth more than every other major carmaker, it's worth more than every other major carmaker combined. And for that to make sense, we can't just be talking about regular car economics. Tesla would have to find a way to one day earn far more money from each vehicle than carmakers do today, which seems a tall order in a competitive market. Or it has to earn a lot of money in adjacent businesses. So where is this money going to come from? Here's Dan.

They pull off a lot more margin because of a lot of the software upgrades, Full Self-Driving and others. You know, you could have $10,000, $12,000 per vehicle, and that flows all the way to the bottom line. So I think that's the other difference, is that the software piece is a huge part of the leverage in the Tesla story.

That reminds me of Apple. Apple's the biggest U.S. company, and it has been catapulted from a stock market value of $500 billion to nearly $2 trillion in less than 4 years. Now, there are a lot of reasons. It sold a heck of a lot of phones. And new accessories like AirPods, but one of the biggest reasons is that Apple has sold more services like storage and music and TV subscriptions and the cut it gets when it sells software in its App Store. That service revenue comes with high profit margins and it tends to be steady, not lumpy from quarter to quarter and year to year like phone sales. So it has not only driven Apple's profits higher, it has also made investors willing to pay a much higher multiple of earnings for shares. As recently as 2 years ago, Apple stock sold for less than 15 times forward earnings projections. Now it's close to 30 times. Whether that valuation is warranted or not is open to discussion, but it explains how the stock has climbed so far so fast. Tesla sells software and services too, like a $10,000 package that adds self-driving capabilities and a $2,000 add-on that boosts acceleration. Owners of older models can pay $2,500 for an upgrade to their infotainment systems. There's talk of a subscription model for battery charging. We've spoken in the past on this podcast with Adam Jonas, who covers Tesla for Morgan Stanley. He upgraded Tesla stock just recently from equal weight to overweight, or Morgan Stanley's version of going from hold to buy. One reason is that Adam thinks Tesla could one day make more profit selling Tesla owners add-on services and insurance than it makes selling the cars themselves. Under his most optimistic assumptions for long-term sales, he thinks the stock is worth more than $1,000 today. Implying a lot more upside potential. Hopefully that's useful for investors wondering about the stock. I'm not taking a view on it either way because I'm struggling to make sense of the math. My base case is that I'll look like an old fuddy-duddy if the stock continues to soar, and all those Tesla bulls will laugh at me for not understanding the internet or cars or internet cars. But my bull case is that I'll benefit indirectly via my S&P 500 fund. Technically, if the stock goes up a lot over the next year, I think index investors are entitled to brag that they added some Tesla around last Christmas. Meta, do we have time to say just a few words about casual dining chains? Sure. Okay, we've spoken on this podcast with the chiefs of Chipotle and Papa John's about how they're doing quite well during the pandemic on delivery and takeaway orders, including digital ordering. And the drive-through line at the McDonald's near me is so busy it's McNuts. But what about sit-down restaurants? They've gone from shutdowns to limited capacity openings in many states, and some have done well with outdoor dining, but winter has me worried because it gets too cold in many markets for eating outdoors. And because the virus is raging again. For an update on the industry, I put in a call to Dennis Geiger, who covers restaurants for UBS. Hi, Dennis.

Hello.

Hi, it's Jack Howard-Bearns. Yes, how are you? Doing well. Thanks for making a few minutes to speak with me. Meta, that how you doing exchange wasn't great either. Dennis asked how I am, and I don't feel like I gave a very full or thoughtful answer. Dennis, If you're listening, thank you for asking, and I'm doing well. This year I've started wearing a lot of flannel-lined pants, and I'm finding that they make the cold weather much more bearable. But things aren't perfect. My dishwasher, it stopped drying the dishes. I have to have it looked at. Also, Meta has bunions. Now then, restaurants. I asked Dennis to tell me about a chain that has been doing better than the others during the pandemic, and his answer might sound surprising. He mentioned a steakhouse called Texas Roadhouse. With stores and restaurants, analysts watch a measure called same-store sales. It ignores newly opened and recently closed locations to show just how longstanding locations are performing. At Texas Roadhouse, same-store sales growth turned positive during October. In other words, the company isn't just doing better than it was during the shutdown, it's doing better than it was before the shutdown. Here's Dennis.

So that's pretty incredible when you think about this is a casual dining restaurant that yes, does have some outdoor seating, does have an off-premise business, you know, where folks can do curbside pickup, et cetera. But at the end of the day, it's a dine-in restaurant. Restaurant that's the focus. And, you know, as of October, they actually got back to just, you know, just positive sales year on year.

I don't think of steak as a food that's a popular choice for delivery, so I asked Dennis, what's Texas Roadhouse doing right? He said it benefits from operating in rural and suburban markets where shutdowns weren't as severe, and that it's growing from a small base on takeaway orders. Dennis also says a company called Brinker is doing well. That's the owner of Chili's. Its same-store sales are about back to flat versus a year ago. Delivery has helped, including something new, a chicken wing business.

They've got a concept called It's Just Wings. You can only order it online digitally for delivery, and it's being done out of the Chili's kitchen, as an example. But that is something where, hey, we've got capacity in the kitchen. We're going to launch, you know, a brand that travels well to the consumer, to the customer. Folks are going online and ordering delivery quite a bit now. Wings, again, travels well. And that's, you know, helping to give us a little bit of a sales boost.

Okay, so Texas Roadhouse and Brinker are doing well. Who's struggling? Dennis says Darden Restaurants, which owns Olive Garden. But it's not so bad for Darden. The main reason it's struggling this year is because it was doing so well last year.

The year-on-year comparison becomes difficult, right? If I'm busy Tuesday through Sunday last year, this year that becomes really hard if my capacity is only at 50%.

What about the latest spike in COVID cases? Is that affecting Dennis's outlook? It is. UBS does surveys every week. The COVID spike has happened so quickly that it's not yet reflected in reported sales numbers, but there are signs of weakness in survey responses.

I would say over the last several weeks, we certainly have seen things get a touch more negative where it looks like consumers are being, you know, a little bit more cautious. I'm not ready yet. You know, there was a greater percent that was ready to go back a month and a half ago versus This is today's—

There are also signs of weakness in reservations made through online services like OpenTable. But again, there are vaccines on the way. I asked Dennis how long it will take for industry sales to fully recover. He said that what the industry calls quick-service restaurants, or what you might call fast food, should recover by next year, and that casual dining's recovery could stretch into 2022. He also said that even though Texas Roadhouse is doing well now and Darden, the Olive Garden owner, is lagging behind, his top stock pick among casual dining companies is Darden because it's done a lot of cost cutting, and when sales recover, it could reach profit margins that are higher than those from before the pandemic. So what about mom-and-pop operators? Big chains can issue new shares or bonds if they need financing to ride out a downturn, but many independent restaurant operators are struggling financially. What should they be thinking about the outlook for restaurants in general after the pandemic? Dennis says that share of stomach, that's his term for market share among all food sellers, including grocery stores, has shifted away from restaurants toward grocers, but it could shift back. And Dennis says that as sales recover, especially if there's a new stimulus deal, mom-and-pop operators can benefit from having gone through some of the same cost-cutting that big chains have done.

I think it's kind of forcing a lot of restaurants to tighten up on their costs. You know, I think we're seeing labor margins and expenses being run a little bit tighter. You know, certainly if your dining room is closed, those savings are not going to be here forever. But I do think there's a sustainability to some of the cost and margin benefits that we've seen in 2020, and I think you'll see some of those stick looking ahead. So hopefully there's a stimulus that comes and provides support to some of the industry in '21. But ultimately, we think the demand for restaurants in whatever format it takes ultimately is going to be pretty good over the next several years.

I love the phrase share of stomach. I've seen a little— there's been a little market expansion in my own share of stomach during this pandemic.

I think we've all seen a little bit of that, I think.

Thank you for listening. Meta Lutzoff is our producer. She loves a good vegan meatloaf, and who wouldn't? Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @jackhowe. H-O-U-G-H. See you next week.

At CLA, we're in your corner and on it. We coach tax strategies and Little League first base. We help you adopt AI data tools and we adopt Rescue's name Buddy. We walk your factory floor and jog the local 5K. Though sometimes we walk that too. Wherever you're coming from, we're right there with you. Wherever you're going, we'll get you there. CLA—CPAs, Consultants, and Advisors. Learn more at claconnect.com/withyou.