Imagine that a billionaire value investor wants to show that Wall Street money managers are swayed more by glamor and group-think than the rooting out bargains. Say this fellow, whom we’ll call Mister Waldorf for his walrus mustache and old-school manner, invites half of dozen of these hotshots to lunch at his stuffy private club requiring jackets and ties, asks them to take a brief exam for a mystery enterprise he calls “Blindfold Inc.”
On Mister Waldorf’s direction, the investors all decline cocktails, and after lunch, their host hands them a one page summary for an unnamed company that he identifies only as a fast-grower and master of innovative technology. “My friends,” intones Waldorf, “please study these numbers for 15 minutes, and tell me, whether you’d buy this stock.”
Separating the winners from the dogs is what Waldorf’s guests pride themselves on, so they dig in with gusto. The bullet points reveal that Blindfold Inc. posted net losses of $1 billion over the past four quarters, but that revenues have more than tripled since 2016 to around $30 billion last year. Its market cap is now $110 billion. Waldorf doesn’t make any assumptions about the returns his guests would expect from Blindfold, but notes that for the shares to rise at 10% a year, its market value would need to reach $220 billion in the 7 year period through the close of 2026.
The summary notes that if the stock commanded a P/E ratio of 30 in 2016, it would need to generate over $7 billion in net earnings. An excellent return on sales—net profits as a percentage of revenues—for the industry is around 7%, and that most of Blindfold’s competitors fall in the 5% to 6% range. Achieving a 7% margin requires expanding revenues to over $100 billion. That’s a three-and-a-half times its current sales of $30 billion.
The bullet points further note that Blindfold would need to grow the units it sells four-fold, and in doing so, capture 35% of the total increase in units sold worldwide, despite competition from entrenched competitors.
The fifteen minutes are up. “So is it yes or no?” queries Waldorf. “I just can’t bet on a company that needs to achieve those kinds of growth rates for that long. That hill is just too steep to climb,” grouses one guest. “It’s a no.” “What if they’re successful, meaning they grow decently but not at the astounding rate required?” says another. “Then the stock collapses, and it’s doing pretty well, but my folks in my fund are furious cause they’re not!” “I need a brandy,” says a third guest. “Are the players in this business that are a lot bigger than Blindfold really going to let it take one-third of tomorrow’s market away from them? It’s a fantasy.”
All six guests vote “no.” Then Waldorf rips the blindfold from “Blindfold Inc,” and reveals that it’s Tesla. The invitees didn’t guess, because Waldorf disguised his subject by adding 20% to all of Tesla’s real numbers. A couple of guests sheepishly acknowledge owning the electric vehicle-maker’s shares. “It’s special, it’s the future,” says one. “Tesla was one of the great stocks of 2019,” says another. “If we’d have bolted, we’d have missed a 35% gain!”
“I acknowledge that Tesla has lots of panache,” allows Waldorf. “But I don’t pay for panache. My blindfold test shows that when the panache is stripped away, and you’re faced with the pure numbers and hurdles, all of you judge that Tesla as a nameless, robo-stock is a lousy buy.” Waldorf gets nods from two investors who shunned Tesla because they too followed the numbers and shunned the glamor, and polite handshakes from the believers. For them, Waldorf is as hopelessly old fashioned as the ivy adorning the walls of his club.
In reality, Tesla’s market cap is $89 billion—by the way, closing in Volkswagen’s valuation—so that delivering 10% returns would hoist its value to $180 billion by the end of 2016. That can only happen if its sales surge from $25 billion to over $80 billion. Reaching those targets mandates capturing one-third of the projected increase in all luxury car sales, leaving Volkswagen’s Audi, Daimler-Benz, BMW and the other premium manufacturers to divide up what’s left, and struggle with paltry growth while Tesla flourishes.
Whenever you get intoxicated by Tesla’s glamor and daring, remember Mr. Waldorf’s blindfold test.
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