Despite Tesla’s stock losing more than 60% of its value since November 2021, recent analyst reports from JPMorgan indicate that the stock would have to drop by an additional 35% to reach fundamental value. However, a behavioral analysis suggests that the number might be closer to 75% due to downplaying base rates and representativeness in the report’s methodology.
The JPMorgan report estimates Tesla’s enterprise value to be $331,483 million by the end of 2024, based on a minimum level of future profitability that investors would find acceptable. The calculation involves determining Tesla’s return on invested capital and dividing it by the weighted average cost of capital. However, assumptions about Tesla’s profitability going forward may be overstated given the increasing competition in the electric vehicle market.
Tesla’s return on invested capital has fluctuated in recent years, with the company facing competition from various automobile manufacturers. Standard economic principles suggest that for a company to earn more than its cost of capital in the long run, it must have a sustainable competitive advantage. Given Tesla’s changing situation and decreasing demand for its vehicles, its return on invested capital may come under pressure.
Analysts often use discounted free cash flow analysis to determine a company’s fundamental value, applying a multiple to estimate future cash flows. However, using multiples that imply expectations of high profitability can lead to overvaluation. By considering the long-term growth rate of free cash flow and comparing it to the company’s cost of capital, analysts can arrive at a more accurate valuation that accounts for realistic growth expectations.
The disparity between Tesla’s fundamental value and market price indicates that the stock is driven mainly by optimistic sentiment. Behavioral asset pricing theory suggests that market prices can be decomposed into fundamental and sentiment components. By incorporating a Tesla-specific sentiment component, analysts can provide a more nuanced target price that reflects both fundamental value and market sentiment.
Ultimately, Tesla’s stock price illustrates the significant impact of sentiment on short-to-medium-term stock movements. Analysts can benefit the investing public by transparently structuring their valuation reports to consider both fundamental and sentiment components, while also being mindful of base rates and avoiding biases that may lead to overestimating future profitability. This approach could help align market prices more closely with fundamental values for Tesla and other stocks.
