Is Tesla worth US$219

• Tesla’s estimated fair value is US$182 based on 2 Stage Free Cash Flow to Equity
• Tesla’s US$219 share price signals that it might be 20% overvalued
• Our fair value estimate is 27% lower than Tesla’s analyst price target of US$248

In this article we are going to estimate the intrinsic value of Tesla, Inc. (NASDAQ:TSLA) by taking the expected future cash flows and discounting them to their present value. Our analysis will employ the Discounted Cash Flow (DCF) model. It may sound complicated, but actually it is quite simple!

Companies can be valued in a lot of ways, so we would point out that a DCF is not perfect for every situation. If you want to learn more about discounted cash flow, the rationale behind this calculation can be read in detail in the Simply Wall St analysis model.

View our latest analysis for Tesla

Is Tesla Fairly Valued?

We’re using the 2-stage growth model, which simply means we take in account two stages of company’s growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. To start off with, we need to estimate the next ten years of cash flows. Where possible we use analyst estimates, but when these aren’t available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, and so the sum of these future cash flows is then discounted to today’s value:

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 2.2%. We discount the terminal cash flows to today’s value at a cost of equity of 9.7%.

Terminal Value (TV)= FCF2033 × (1 + g) ÷ (r – g) = US$66b× (1 + 2.2%) ÷ (9.7%– 2.2%) = US$894b

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= US$894b÷ ( 1 + 9.7%)10= US$353b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$576b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$219, the company appears slightly overvalued at the time of writing. Valuations are imprecise instruments though, rather like a telescope – move a few degrees and end up in a different galaxy. Do keep this in mind.

The Assumptions

The calculation above is very dependent on two assumptions. The first is the discount rate and the other is the cash flows. If you don’t agree with these result, have a go at the calculation yourself and play with the assumptions. The DCF also does not consider the possible cyclicality of an industry, or a company’s future capital requirements, so it does not give a full picture of a company’s potential performance. Given that we are looking at Tesla as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we’ve used 9.7%, which is based on a levered beta of 1.516. Beta is a measure of a stock’s volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Tesla

Strength

Earnings growth over the past year exceeded the industry.

Debt is not viewed as a risk.

Weakness

Earnings growth over the past year is below its 5-year average.

Expensive based on P/E ratio and estimated fair value.

Opportunity

Annual earnings are forecast to grow faster than the American market.

Threat

Revenue is forecast to grow slower than 20% per year.

Next Steps:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. What is the reason for the share price exceeding the intrinsic value? For Tesla, there are three fundamental factors you should assess:

Risks: Be aware that Tesla is showing 1 warning sign in our investment analysis , you should know about…

Future Earnings: How does TSLA’s growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.