Back in March of 2000 we published an article in our On the Money print newsletter that discussed one of the hottest stocks of the day, Cisco, known for making the routers that powered the internet. Unlike many of the dot.com darlings, Cisco had actual profits. But, like most of the tech stocks back then, it was selling at a very high valuation. We worked through the math and explained why the stock was really overpriced. Within a few days of publication, Cisco stock peaked and then, with the dot.com crash, fell about 90% over the next year and a half. Cisco, unlike many of the dot.com companies, is still around today and doing very well. But had you bought the stock in March, 2000, twenty years later your investment would still have been showing a significant loss.
This year we’ve seen some of the same kind of senseless valuation levels. Most stocks are expensive, but some seem to be trading at ridiculous levels. Let’s take a look at Tesla and compare it to another car company, Ford.
Ford, of course, has been around forever and, for 2020, was the third largest US auto producer with almost a 14% market share. The company has typically been a steady grower, with profits subject to the ups and downs of the economy and has traded at a modest Price Earnings (PE) ratio, often dipping into the single digits. Today, with generally higher PE ratios and excitement around the upcoming F-150 electric truck and the Mustang Mach E, Ford stock is up nicely and trading at 29 times earnings.
Tesla, on the other hand, is an upstart in the auto industry. For 2020, they produced just 2% of the US built autos, though their share has been rising nicely and they are a fast-growing company. Growth companies sport higher PE ratios, but Tesla’s is at an astronomical 313 today. To put that in perspective, if you owned $10,000 in Tesla stock today your share of the annual earnings comes to about $32, none of which is paid out in dividends. If you could get a bank to pay you 1%, that would give you a guaranteed $100 on your same $10,000.
Earlier this week, Time magazine named Elon Musk as their Person of the Year. He’s the wealthiest individual on the planet with a net worth of over $250 billion and, by most anyone’s account, a rather brilliant guy. He’s Tesla’s largest shareholder and last month asked his 66 million Twitter followers if he should sell 10% of his shares in Tesla. Tesla stock had traded at over $1,200 per share over the prior three days. The Twitter poll was in favor of his sale and he has been unloading his shares over the past month, with about 7% of his stake sold so far. His selling, along with a general decline in the NASDAQ stocks, have pushed the price down about 20%, but the company is still worth nearly $1 trillion.
Depending on his selling prices, Musk may see sale proceeds of about $17 billion or more. Assuming little to no basis, the federal capital gains taxes would likely come in at about $4 billion and his recent move from California to Texas means he’ll likely escape any state capital gain taxes. California’s capital gains rate maxes out at 6% so he could save about $1 billion versus the 0% rate in Texas. His after-tax proceeds then may come to about $13 billion. Based on his share of Tesla, his share of the company’s earnings would be only about $600 million over the last year and so he’s only giving up about $60 million (10% of his stake) for an after tax $13 billion! Seems like a smart move.
Yet other investors are buying up the shares that Musk is selling. And this year we’ve seen a lot of people buying similarly expensive stocks, crypto coins, and NFTs, all of which are of questionable value. As we saw in the dot.com bust, these bubbles can end badly even for large “can’t miss” companies like Cisco. It may well be time to follow the smart guys like Musk and take some profits at today’s crazy valuations.