A lot of people don’t really understand the concept of a stock valuation. They see the stock market as a big casino where people can make bets on what might might go up or down. But the big difference between a stock and a casino bet is this. When you buy a stock, you are buying company ownership. Unlike a blackjack bet, you’ve bought something which you own. You own a piece of the future profits of a company.
But when you tell the average non-financial person that a stock is the present value of future cash flows discounted by the cost of capital, their eyes kind of glaze over and they smile and say “whatever”. So I thought I’d take a stab at putting this into terms that anyone can understand.
Starbucks Is Coming to Town
Say you live in a town that doesn’t have a Starbucks in it and Starbucks just announced that they are opening a new location there in 3 months. To celebrate, they are offering 500 coupons for a free Venti Latte in the opening week. And to prevent long lines on opening day, only coupon holders will be served. The first 500 people to register at the website will have their coupon mailed to them prior to the grand opening.
So far so good. 500 people in town now have a coupon for a free Latte. And everyone knows what it’s worth because everyone knows what a Latte normally costs, about $5.00. The coupon isn’t like a lottery ticket. You don’t just have a chance to score a latte. The fact that you have the coupon in your possession represents a future financial benefit, just like a stock.
But what about all those people who didn’t get a coupon? Say that some particularly big Starbucks fans want to say that they were at the grand opening on Day 1. They offer to buy Starbucks coupons from holders at a premium. They are willing to pay $20 for a $5 latte if someone will sell them their coupon. All of a sudden, the trading value of that $5 Latte just went to $20.
Let’s add another twist. Let’s say that the new Starbucks store manager noticed the rise in coupon value to $20. He’s in danger of filing for personal bankruptcy and he held back 100 coupons for himself to give away. But now he wants to quietly sell them. And he starts making predictions that they will be adding new flavors never before seen at any other Starbucks. Overnight, the worth of the coupons goes to $50.
Excited at what just happened, the new Starbucks manager now is making claims that they have invented coffee that will take away your arthritis pain for the day. They will offer it at the grand opening. The coffee coupons just went to $200 per coupon. But this new Starbucks manager was deep in debt and in danger of losing his house. So now he’s making claims that they will unveil a coffee mixture that can cure cancer. A month before his grand opening he stages a “Cancer Day” event. His coupons just soared in value to $5000 each.
The new Starbucks manager sells his $5 latte coupons for $5,000 each to make a cool half million dollars. He is now out of debt and paid off his house. He is riding high on his success and now hated by all the other coffee shop owners. They all see that he can’t deliver on his promises and he’s making them look bad by comparison. When is their coffee going to start curing cancer and making the world a better place? They are just waiting for the inevitable implosion.
And now we run into the big problem. There are no new flavors and coffee will never cure arthritis or cancer. So what does he do? He delays the grand opening when everyone would “cash in” their coupon. This worked the first time. But eventually, everyone realized that they had paid $5,000 for a coupon that was worth a $5 latte. The price collapses and resets to $5.00.
The Tesla Bubble
Tesla’s stock bubble has grown so large, that many people are questioning the very concept of a stock valuation. You’re now hearing alarming phrases along the lines of “it’s different this time”, “it’s a new economy”, “Elon rewrote the rules”. This always happens with a stock bubble. Everyone always thinks that it’s different this time.
The only thing that is different is this. Social media has allowed bubbles to grow larger and last longer than before. Musk has tapped into new social media tools to grow his bubble larger than anyone thought possible. But a larger bubble is still just a bubble unless it has real profits which you own.
And thus far, Tesla has almost no profit from making cars. All this talk about “profits” from Tesla in the past year is ignoring the fact that without government mandated carbon credits, Tesla is losing up to $100 million dollars per month.
Where Tesla and My Starbucks Example Are Alike
I specifically chose Starbucks Coffee in my valuation example for this reason. By my estimates, a share of Tesla’s stock is worth about as much as a Venti Latte from Starbucks. People are literally paying over $800 for something that’s worth no more than a cup of coffee.
If I ignore all the fantasy stories that Tesla apologists spin about how Tesla isn’t an auto company, and apply cold hard math to discounting their future profits, I get a stock valuation that is in the single digits
And here’s what is more troublesome for Tesla investors. Even if every government on Earth were to outlaw vehicles powered by internal combustion engines (ICE) and Tesla captured 90% of the market, the profit generated wouldn’t even come close to justifying today’s stock valuation.
The major problem with investing in Tesla’s stock is this. It is not based on selling cars. It is assuming that Tesla can revolutionize the energy industry, the taxi industry, housing and more. When Tesla’s stock price got as high as it could go based on dominating the auto industry, Musk started promising more things to keep the price going up.
This is something that most new Tesla investors don’t realize. They think they are investing in a car company. But even if the Biden administration outlawed gasoline powered cars in 2022, Tesla is still wildly overvalued. Because the future profits from selling cars is only a fraction of what makes up the stock price. If you buy into Tesla today, you are dependent on Tesla growing way beyond automotive. Good luck with that. Because thus far Tesla is only a tiny sliver of automotive and they are, by far, the worst auto manufacturer on the planet in terms of quality, customer service, and profitability.
Where Tesla and My Starbucks Example Are Different
The major difference between Musk and my mythical Starbucks manager is this. Tesla has no hard date whereby they would redeem all their stock. In my Starbucks story, there was a grand opening date where you could go in and redeem your coupon for a cup of coffee. At that point, the trading of the coupons would stop and everyone would acknowledge that they were getting a $5 cup of coffee in exchange for their coupon. Regardless of whether they paid $5,000 for the coupon, they were getting a $5 cup of coffee. The price is “corrected” and they lose their money if cancer isn’t cured.
The big question for Tesla is how long before people lose faith that this company will generate massive profit in multiple industries? Because when that happens, they will no longer be able to raise money and the stock will plummet in value. Everything that happened to Tesla’s stock over the past 18 months will reverse in a matter of weeks, if not days.
The Big Short
Michael Burry became famous when a movie was made out of his steadfast belief that the housing bubble would one day collapse. He believed it even though everyone told him he was wrong and the bubble just kept getting larger and larger. It eventually popped and he was proven right. There was a massive coordinated effort by many parties to keep the gravy train going. But just because a bubble keeps getting larger, doesn’t mean that it isn’t eventually going to pop. Here’s a little of what he said recently.
Of the idea that Tesla's lofty stock price is self-fulfilling because the business can issue shares to fund its growth, Burry said, "Saw this same thesis many times while partying in 1999."
"My last Big Short got bigger and Bigger and BIGGER too," he said in another tweet. "Enjoy it while it lasts." —Michael Burry, Market Insider 02-16-21
Burry maintains steadfastly that the fervor for Tesla stock is eerily similar to the housing bubble and that it’s going to end the same way. It may take years, but I think he’ll be proven right again.
A share of Tesla stock is worth no more than a cup of coffee and people are paying wild premiums because they think that Tesla has amazing growth opportunities ahead. Those growth opportunities were priced into the stock long ago. Soon Musk will have to start promising profits from manufacturing on Mars or asteroids to keep the stock price going up.
Tesla’s “growth opportunities” are tantamount to curing cancer with coffee. They are fantasy. But if you believe that, I’ve got a Venti Vanilla Latte that I’ll sell you for $1,000.
Starbucks Is Coming to Town
Say you live in a town that doesn’t have a Starbucks in it and Starbucks just announced that they are opening a new location there in 3 months. To celebrate, they are offering 500 coupons for a free Venti Latte in the opening week. And to prevent long lines on opening day, only coupon holders will be served. The first 500 people to register at the website will have their coupon mailed to them prior to the grand opening.
So far so good. 500 people in town now have a coupon for a free Latte. And everyone knows what it’s worth because everyone knows what a Latte normally costs, about $5.00. The coupon isn’t like a lottery ticket. You don’t just have a chance to score a latte. The fact that you have the coupon in your possession represents a future financial benefit, just like a stock.
But what about all those people who didn’t get a coupon? Say that some particularly big Starbucks fans want to say that they were at the grand opening on Day 1. They offer to buy Starbucks coupons from holders at a premium. They are willing to pay $20 for a $5 latte if someone will sell them their coupon. All of a sudden, the trading value of that $5 Latte just went to $20.
Let’s add another twist. Let’s say that the new Starbucks store manager noticed the rise in coupon value to $20. He’s in danger of filing for personal bankruptcy and he held back 100 coupons for himself to give away. But now he wants to quietly sell them. And he starts making predictions that they will be adding new flavors never before seen at any other Starbucks. Overnight, the worth of the coupons goes to $50.
Excited at what just happened, the new Starbucks manager now is making claims that they have invented coffee that will take away your arthritis pain for the day. They will offer it at the grand opening. The coffee coupons just went to $200 per coupon. But this new Starbucks manager was deep in debt and in danger of losing his house. So now he’s making claims that they will unveil a coffee mixture that can cure cancer. A month before his grand opening he stages a “Cancer Day” event. His coupons just soared in value to $5000 each.
The new Starbucks manager sells his $5 latte coupons for $5,000 each to make a cool half million dollars. He is now out of debt and paid off his house. He is riding high on his success and now hated by all the other coffee shop owners. They all see that he can’t deliver on his promises and he’s making them look bad by comparison. When is their coffee going to start curing cancer and making the world a better place? They are just waiting for the inevitable implosion.
And now we run into the big problem. There are no new flavors and coffee will never cure arthritis or cancer. So what does he do? He delays the grand opening when everyone would “cash in” their coupon. This worked the first time. But eventually, everyone realized that they had paid $5,000 for a coupon that was worth a $5 latte. The price collapses and resets to $5.00.
The Tesla Bubble
Tesla’s stock bubble has grown so large, that many people are questioning the very concept of a stock valuation. You’re now hearing alarming phrases along the lines of “it’s different this time”, “it’s a new economy”, “Elon rewrote the rules”. This always happens with a stock bubble. Everyone always thinks that it’s different this time.
The only thing that is different is this. Social media has allowed bubbles to grow larger and last longer than before. Musk has tapped into new social media tools to grow his bubble larger than anyone thought possible. But a larger bubble is still just a bubble unless it has real profits which you own.
And thus far, Tesla has almost no profit from making cars. All this talk about “profits” from Tesla in the past year is ignoring the fact that without government mandated carbon credits, Tesla is losing up to $100 million dollars per month.
Where Tesla and My Starbucks Example Are Alike
I specifically chose Starbucks Coffee in my valuation example for this reason. By my estimates, a share of Tesla’s stock is worth about as much as a Venti Latte from Starbucks. People are literally paying over $800 for something that’s worth no more than a cup of coffee.
If I ignore all the fantasy stories that Tesla apologists spin about how Tesla isn’t an auto company, and apply cold hard math to discounting their future profits, I get a stock valuation that is in the single digits
And here’s what is more troublesome for Tesla investors. Even if every government on Earth were to outlaw vehicles powered by internal combustion engines (ICE) and Tesla captured 90% of the market, the profit generated wouldn’t even come close to justifying today’s stock valuation.
The major problem with investing in Tesla’s stock is this. It is not based on selling cars. It is assuming that Tesla can revolutionize the energy industry, the taxi industry, housing and more. When Tesla’s stock price got as high as it could go based on dominating the auto industry, Musk started promising more things to keep the price going up.
This is something that most new Tesla investors don’t realize. They think they are investing in a car company. But even if the Biden administration outlawed gasoline powered cars in 2022, Tesla is still wildly overvalued. Because the future profits from selling cars is only a fraction of what makes up the stock price. If you buy into Tesla today, you are dependent on Tesla growing way beyond automotive. Good luck with that. Because thus far Tesla is only a tiny sliver of automotive and they are, by far, the worst auto manufacturer on the planet in terms of quality, customer service, and profitability.
Where Tesla and My Starbucks Example Are Different
The major difference between Musk and my mythical Starbucks manager is this. Tesla has no hard date whereby they would redeem all their stock. In my Starbucks story, there was a grand opening date where you could go in and redeem your coupon for a cup of coffee. At that point, the trading of the coupons would stop and everyone would acknowledge that they were getting a $5 cup of coffee in exchange for their coupon. Regardless of whether they paid $5,000 for the coupon, they were getting a $5 cup of coffee. The price is “corrected” and they lose their money if cancer isn’t cured.
The big question for Tesla is how long before people lose faith that this company will generate massive profit in multiple industries? Because when that happens, they will no longer be able to raise money and the stock will plummet in value. Everything that happened to Tesla’s stock over the past 18 months will reverse in a matter of weeks, if not days.
The Big Short
Michael Burry became famous when a movie was made out of his steadfast belief that the housing bubble would one day collapse. He believed it even though everyone told him he was wrong and the bubble just kept getting larger and larger. It eventually popped and he was proven right. There was a massive coordinated effort by many parties to keep the gravy train going. But just because a bubble keeps getting larger, doesn’t mean that it isn’t eventually going to pop. Here’s a little of what he said recently.
Of the idea that Tesla's lofty stock price is self-fulfilling because the business can issue shares to fund its growth, Burry said, "Saw this same thesis many times while partying in 1999."
"My last Big Short got bigger and Bigger and BIGGER too," he said in another tweet. "Enjoy it while it lasts." —Michael Burry, Market Insider 02-16-21
Burry maintains steadfastly that the fervor for Tesla stock is eerily similar to the housing bubble and that it’s going to end the same way. It may take years, but I think he’ll be proven right again.
A share of Tesla stock is worth no more than a cup of coffee and people are paying wild premiums because they think that Tesla has amazing growth opportunities ahead. Those growth opportunities were priced into the stock long ago. Soon Musk will have to start promising profits from manufacturing on Mars or asteroids to keep the stock price going up.
Tesla’s “growth opportunities” are tantamount to curing cancer with coffee. They are fantasy. But if you believe that, I’ve got a Venti Vanilla Latte that I’ll sell you for $1,000.
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