Electric vehicle makers can’t catch a break.
Their stock was getting crushed again Friday. But the reason had nothing to do with business fundamentals. Sales are still strong and, if anything, EV penetration of the new car market is growing faster than anyone expected.
The problem is math.
Rising interest rates hurt high-growth stocks far more than low-growth stocks. That’s because high-growth companies generate most of their cash and earnings years down the road. Future cash becomes worth less in today’s dollars as rates increase partly because investors have more opportunity to earn bigger returns from assets paying higher interest and dividends right now.
The question for investors: How much do rates hurt a stock such as Tesla (ticker: TSLA)?
It isn’t that hard to figure out. All that’s required is a spreadsheet and the hubris to forecast cash flow for a generation.
Wall Street expects Tesla to generate roughly $2 billion in free cash flow in 2021, growing to about $21 billion in free cash flow by 2026. The growth won’t stop there. By 2030, free cash flow could double again. After that, it’s prudent to assume slower growth.
(TM), for instance, can generate about $20 billion a year. So $40-plus billion is a lot for a car company, even Tesla. But, by then, Tesla will have cash flow from other things such as its software and insurance businesses.
With all that as the basis for analysis, every 1% rise in interest rates hurts Tesla’s value by about $200 billion, or 25% of $800 stock price target.
Doing the same exercise for Toyota, and its $20 billion in projected cash flows, yields about half the value destruction from higher rates. That’s the way it works for slower growing companies.
Both examples are big simplifications.
To be sure, real life isn’t a spreadsheet. Discount rates used to value stocks don’t change with every tick of the 10-year Treasury note yield. Investors, implicitly, realize things change slowly. But when expectations for higher rates really take hold of investors’ minds, then valuation multiples are affected.
Investors are clearly worried. Tesla shares were down as much as 11% in Friday trading. At one point,
(NIO) stock was off almost 14%. The
S & P 500
Dow Jones Industrial Average
were both up about 0.8%.
Even though Barron’s example is simple, it still yields a useful rule of thumb. One percent can wipe $200 billion from Tesla’s market cap. Now Tesla’s market capitalization is down roughly $400 billion from its peak. Maybe things were a little too euphoric at the peak and perhaps investors are too bearish now. But the wipeout means the expectations for higher rates is real.
Tesla has almost 1 billion shares outstanding, excluding management stock options. So translating the example into share prices is easy. Every billion dollars works out to about $1 in Tesla share price.
That math is simple.
Write to Al Root at email@example.com