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Tesla Inc. shares are climbing at a rapid pace, but it’s becoming increasingly difficult to make a bullish case.
The last time we saw a rally like this, it was supported by double-digit revenue growth. Things look much gloomier now: the sentiment around electric cars is subdued, Tesla’s sales are shrinking, and its profits are declining.
Tesla has surged 44% over an 11-day winning streak, the longest since June 2023. The stock now trades at 90 times forward earnings, a level last seen in early 2022, according to Bloomberg data.
Investors attribute the surge to traders looking beyond Tesla’s EV credentials and betting on Elon Musk's ability to transform it into an artificial intelligence powerhouse. The belief is that when Musk finally unveils Tesla’s much-anticipated self-driving technology — the so-called robotaxi — on August 8, it will cement the company’s position as a leading AI player.
“Investors have been looking for that one breakthrough, real-world application of AI,” said Nicholas Colas, co-founder at DataTrek Research. “And now we have someone who has been working on AI for years saying, ‘Hey, I have that killer application.’”
However, some numbers contradict the current excitement around the stock: earnings are set to drop by 21% in 2024, and revenue growth is expected to slow to just 2.2%.
“This is clearly a faith-based stock now, not one whose valuations are in any way tied to current earnings power, and every day the stock rallies, the bar for the event just gets higher,” Colas added.
The frenetic rally, which led bond billionaire Bill Gross to compare Tesla to meme stocks, gained momentum after the company’s July 2 sales update suggested the worst of the EV slowdown might be over. But the surge has since taken on a wilder momentum.
Tesla is now the fifth-most expensively priced stock in the S&P 500 Index on a price-to-earnings basis, far surpassing the rest of the megacap technology group.
One risk is that Tesla's success in AI relies on solving one of the most complex problems the technology has yet tackled — creating cars that drive themselves more safely than humans can. Most analysts and experts believe that mass adoption of such technology is likely decades away.
Tesla has “always traded on hopes and dreams,” said Steve Sosnick, chief strategist at Interactive Brokers. “If you’re not thinking about the future, the fact that this company is worth almost as much as the rest of the auto industry combined doesn’t make sense. But if you think Elon Musk and Tesla are going to change the world, so what if you’re paying 100 times earnings?”
Despite the high PE ratio, the share price of about $263 is still far from the peak of about $410 reached in November 2021. While Tesla's stock is staging a spectacular turnaround, its earnings are shrinking. In 2021, when the stock rose 50%, annual profit jumped nearly seven-fold.
Predicting whether the rally will break is difficult. However, trading in the options market suggests investors remain optimistic.
“Tesla options market positioning over the next three months has become extremely bullish,” said Vishal Vivek, an equity trading strategist at Citigroup. Options imply traders are positioning for a more than 9% move in either direction when the company reports second-quarter results on July 23, he added.
Traders are bidding up the price of Tesla calls relative to puts, showing a greater desire to chase the rally further, with muted demand for hedges in case the stock slumps.
Still, not everyone is confident enough to jump in.
For David Wagner, portfolio manager at Aptus Capital Advisors, which holds Tesla shares, the uncertainty around what Musk may present on August 8 makes the risk “too high right now to be investing new money into Tesla.”
The intense wave of buying also causes unease for other market participants, who worry the tide may turn.
“The biggest risk to Tesla shares is this level of volatility,” said Michael O’Rourke, chief market strategist at Jonestrading. “Usually, when you have this type of volatility, it works in both directions, so that’s a problem.”
