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Tesla and Forced Opinions

The market can be a cruel arbiter, eventually compelling all to have an opinion, kicking and screaming they might complain, but everyone is forced to place a bet. For much of last year, many, including this author watched in unbelief the incredible ascension of the stock price of Tesla, purveyor of electronic cars with factories in China, Europe and the US. Towards year end the market capitalization exceeded the total capitalization of all its automotive peers.

Any and all of our preferred metrics, have long since been eviscerated. We have a suspicion that the ascension of Tesla should be offset by creative destruction elsewhere in the industry, which we do not see. If we were to seek expert opinion, we would be inclined to listen to Elon Musk, who when commenting last spring with the now post-split stock trading as an equivalent price then of $140.26 per share said simply:

Since that time, even allowing credit for nearly hitting the annual production target of 500,000 vehicles, we struggle to use either a bottom up or top-down framework that explain the move from 140.26 on the 1st of May to the current price ~$660, an increase from the formerly over-valued market cap of 168 billion to 635 billion.

Using entire industries, instead of companies reveals some interesting assumptions as well. The entire energy complex has less value than Tesla, just one of its end customers. Perhaps energy is cheap, though we suspect whatever one’s view, this is not equilibrium.

Certainly, versus peers, the owner’s opinion, and entire industries, the Tesla valuation appears optimistic.

What might we divine from the recent inclusion of the stock in the important indices? Recent years have witnessed several ill-timed and ill-considered changes in the Dow. Most recently Exxon, Pfizer, and Raytheon have been replaced by Salesforce, Amgen and Honeywell. With a bit less subjective emphasis, Tesla was added to the S&P 500 index in October with its then current market cap of nearly 650 billion.

We suspect the inclusion of Tesla in the S&P 500 will eventually have the effect of dampening the relative volatility of this stock as it is increasingly traded in a variety of relative trades amongst index constituents. The FANG stocks, excepting Apple, have exhibited little excess return or volatility in the past 6 months, and we believe Tesla will now join their orbit.

Tesla now has a near 2% weight in the S&P 500 index, at a valuation more than 4x what was recently thought sensible by its owner. What might an open-minded owner of the index consider? A 50% decline in Tesla’s price, towards a relatively recent $310.00 (still more than double Elon’s overvalued assessment made at $140.00) would add 75 basis points of return to our imagined index owner.

Hidden Risk in Long Duration Stocks

Investors searching for safety in low p/e stocks as well as those offering high dividends, have recently found themselves behind in a market that favors new metrics. We have our suspicions about the old- fashioned math and metrics as well, but believe some relationships continue to hold. Among these are the imperative that cash flows received far into the future are worth less than cash flows received currently.

One notable feature of the market in 2021 was the stunning underperformance of stocks that delivered a good yield, as measured by shareholder yield, which is a measure of the total return received by shareholders from both stock buybacks and stock dividends.

Some have characterized this underwhelming performance as attributable to the markets’ fascination with “story” stocks such as Gamestop. Others have created narratives around archaic and often inconsistent definitions of value specified around relationships such as price to book measures. We note that stocks with longer durations, that is longer time frames under which earnings, cash flows, dividends and buybacks will be realized, necessarily have lower current shareholder yields.

There appears to be a high correlation between the return of technology stocks and interest rates. Weighted by capitalization, much of the return from technology stocks will occur far in the future. How far one might ask. To keep this note simple we note that estimates of the duration of the stock market as a whole, is something on the order of 23 years. This measure implies the interest rate risk in long duration stocks is similar to that of a long duration, zero coupon bond. And bond rates are going up with prices going down.

Ten-year rates on US Treasury notes recently moved over 1.50%. While this move has startled some, much higher rates could easily be fathomed in market led by a Federal Reserve wanting to see inflation and a government that appears to believe no amount of deficit spending is too large.

The percentage down move in interest rate products as of this writing, does not appear to be reflected in stocks. Long term interest rates do matter.

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