Hello and welcome back to Reflections on Investing with the Cornell Capital Group.
Today, we’re going to talk about growth options—a topic we’ve addressed in the past. However, with the market down and volatility up, understanding the role of growth options has become particularly critical.
To make this concept practical, let’s consider an example. Tesla is perhaps the best example.
Tesla’s Business Composition
You can think of Tesla’s business as being composed of two parts:
1. Current Business Operations
•Selling cars and light trucks
•Selling energy products such as batteries and solar panels
2. Future Growth Opportunities
•Tesla has announced plans for various innovations that could be far more profitable than its current operations.
If those future opportunities materialize, Tesla’s stock price today reflects not just its current business, but also these potential future opportunities.
Elon Musk’s Growth Projections
No better source to reference than Elon Musk himself. At the last shareholder meeting, he stated:
“I think we could make one Tesla robot for a cost of maybe at really high scale of about $10,000. It would be less expensive than a car. And if we sell it for $20,000, Tesla could make a trillion dollars in profit per year from that. If the price-to-earnings (P/E) multiple is under 20 or 25, that would mean a $2 trillion market cap from Optimus alone—and probably $5 to $10 trillion from autonomous vehicles, which we also don’t sell at this time. It’s conceivable that Tesla could achieve a valuation 10 times that of today’s most valuable company—over $30 trillion market cap.”
These are all growth options. Even if there’s only a remote possibility that these projections materialize within the next decade, when discounted back to the present, Tesla could be far more valuable than Apple despite its current valuation of less than $1 trillion.
The Impact of Growth Options on Tesla’s Stock Price
How do these growth options affect Tesla’s stock price? Let’s examine its historical movements.
•Tesla’s stock price fluctuated between $200 and $250 until the time of the shareholder meeting.
•Following Musk’s comments, it surged to $488 per share.
•This jump was not due to changes in Tesla’s current business, but rather a revaluation of its growth options.
However, growth options are tenuous. Their valuation can skyrocket or collapse based on sentiment rather than actual business performance.
•In recent months, Tesla’s stock has dropped back to under $250 per share.
•Investors are becoming concerned that Tesla’s growth options may not materialize, either because:
•Musk is distracted by political matters.
•Consumer sentiment towards Tesla has weakened.
This illustrates the incredible sensitivity of stock prices to growth options.
Comparing Tesla to Ford: Forward P/E Ratios
To take this analysis one step further, let’s compare Tesla’s 12-month forward P/E ratio with Ford’s.
Why focus on forward P/E? The amount someone is willing to pay for a dollar of future earnings is intimately connected to a company’s growth options.
• Ford’s forward P/E ratio (blue line) remains below 10 the entire time.
• Tesla’s forward P/E ratio fluctuates between 40 and 140.
These drastic movements in Tesla’s stock price are not due to changes in its current business but rather revaluations of its growth options.
What Is Tesla Worth Without Growth Options?
If we strip out growth options, what is Tesla’s actual valuation?
A recent valuation by Aswath Damodaran on his Musings on Markets blog estimates Tesla’s stock price at $148 per share.
However, this valuation includes self-driving software and robo-taxis. If we remove those projections and focus solely on Tesla’s current business, the value drops below $100 per share.
In other words, Tesla’s core business is worth less than $100 per share, while the rest of its stock price reflects growth options.
The Volatility of Growth Options
Because growth options do not yet exist, they are projections of the future—which makes them highly sensitive to market sentiment.
• When investors are confident and demand lower risk premiums, these growth options hold greater value.
• When investors become risk-averse, the value of these future growth options declines substantially.
Given today’s market conditions, we anticipate continued fluctuations in the value of growth options.
Beyond Tesla: Apple’s P/E Ratio Volatility
To conclude, it’s not just companies like Tesla that experience this phenomenon.
•Apple’s P/E ratio has fluctuated between 26 and 38 over the past two years.
•These changes are almost entirely due to revaluations of Apple’s future growth options.
Final Takeaway
If you have money at risk in today’s market, think carefully about:
1. How much of a company’s value comes from growth options.
2. How likely these growth options are to materialize over time.
This has been Reflections on Investing with the Cornell Capital Group.
Thanks for joining us!