It's been a volatile year for Tesla (NASDAQ: TSLA) stock, with shares falling to around $140 in late April, surging to highs above $260 in early July, and then taking a hit following the company's second-quarter earnings release -- putting shares closer to $220. This volatility is representative of the market's fast-changing sentiment for the stock. Deciding what Tesla stock is worth is simply a difficult task.
It's not surprising that Tesla stock is hard to value. This is usually the case when a company is involved in new technologies. Investors interested in owning shares need to not only extrapolate current trends about new technologies like electric cars, energy storage, and solar, but they also have to make predictions about unproven products and services yet to launch. For instance, Tesla investors have to think through the implications of the company's plans in robotics and its promised self-driving taxi network. Forecasting how these moonshot business segments will contribute to Tesla's financials is no easy task.
These uncertain factors make it virtually impossible to know what Tesla stock is worth. Even coming up with a ballpark estimate of its underlying intrinsic value is challenging.
With all of this said, some investors may just deem a stock like Tesla uninvestable. But it's important to remember that uncertainties are part of investing. So, it's OK to embrace them. But how can investors logically approach this difficult-to-value growth stock and still potentially invest in it?
Require a margin of safety
One approach for investors to take when considering investing in an uncertain growth stock is to leave significant room for error in their forecasts. For instance, if their ballpark estimate of the stock's value is somewhere between $200 and $300 per share, they could require shares to trade at a significant discount to their estimate before considering buying. Investors often call this a "margin of safety," which leaves room for error in the case an investor's forecasts about the future prove to be too optimistic.
The more unpredictable a company's business is, the larger margin of safety investors should require. Indeed, given the uncertain nature of Tesla's business, it wouldn't be too drastic to require shares to trade as much as 50% below a fair value estimate before the stock should be bought. So, in our example, an investor may want to avoid buying Tesla stock until it trades somewhere in the range of $100 to $150, or a 50% discount to a fair value estimate range of $200 to $300.
Shares may be too expensive today
So, is Tesla stock a buy when applying this method to the stock? While there's not enough room in this article to fully analyze a stock like Tesla, a glance at the company's current sales and financial trends suggests the current price may not be attractive. Not only did Tesla's automotive revenue fall 7% year over year in the company's most recent quarter but the stock's price-to-earnings ratio of 63 leaves very little room for error in any optimistic forecast for the company's long-term growth potential.
A valuation like this arguably prices in both a return to strong growth in automotive sales and positive future financial contributions from nascent and untested businesses like an autonomous driving fleet and robotics. This is a tall (but still possible) order. Given this frothy valuation, it may make more sense for investors to give themselves a big margin of safety.
But investors should keep in mind this caveat: Even though there is a process to buying uncertain stocks (requiring a significant margin of safety), investors should also ask themselves whether they have the right risk tolerance or financial situation to own a stock like this in the first place. It's safe to say that no one really knows what Tesla stock is worth, so buying shares is inherently risky. Further, shares are notoriously volatile.
