The stock market in 2023 witnessed an electrifying surge led by the “Magnificent Seven,” comprising technology giants like Tesla, Nvidia, Apple, Amazon, Meta Platforms, Microsoft, and Alphabet. The collectively awe-inspiring rise of these companies, ranging from 50% to 250%, played a pivotal role in propelling the overall market to stellar gains.
However, beneath the glittering surface of this eruption lie red flags that discerning investors should be cognizant of as they brace for potential tremors in 2024.
2023 Frenzy: More Hype Than Substance?
Looking ahead is a natural instinct for investors—and Tesla, in particular, seemed to bask in the glow of future promises. Elon Musk’s fervent advocacy, amplified through his ownership of the social media platform X, fanned the hype around Tesla’s futuristic endeavors such as the Cybertruck, Tesla Bot, and strides in artificial intelligence (AI).
However, Tesla’s current revenue stream heavily relies on the sales of its existing electric vehicle models (S, 3, X, and Y). Aggressive price reductions to bolster unit sales have significantly dented the company’s profit margins. Starting at 17% in January, Tesla’s operating margins have withered to just under 11% in less than a year.
While some argue that Tesla’s price cuts are an offensive strategy to expand market share and enhance factory efficiency to reduce costs per unit, the practical effectiveness of this approach remains uncertain.
Dwindling Expectations
Investors are eager to witness a turnaround where the downward spiral of operating margins halts and the surge in sales volume commences bolstering Tesla’s financial performance. Nevertheless, analysts have tempered their long-term expectations, downgrading the estimated annual earnings growth from 24% to below 17%.
The Stock’s Ascent Amidst Growing Concerns
Traditionally, escalating risks prompt a downward trajectory in stock prices. Nevertheless, Tesla has defied this norm, soaring by an astonishing 120% in 2023. A lack of commensurate earnings growth has rendered Tesla stock considerably more expensive, with shares trading at a forward P/E multiple of 78 while operating margins continue their decline.
The current PEG ratio of over four further accentuates the stock’s lofty valuation, signaling overvaluation relative to its anticipated earnings growth. Amidst diminishing margins and a looming deceleration in earnings growth, the stock’s triple-digit surge appears tantamount to challenging gravity—a feat that, in due course, gravity is bound to triumph over.
Consequently, investors should exercise prudence before pursuing Tesla stock at its current valuation. The prevailing conditions present a compelling case for the stock to retreat, particularly if the broader market encounters turbulence in 2024. While a reversal in this scenario is conceivable if Tesla can substantiate the efficacy of its strategy, the current valuation offers little room to justify such a leap of faith.
*Stock Advisor returns as of December 18, 2023