Tesla has followed the market’s trajectory closely, rising in tandem with the S&P 500 over the past six months. The stock has climbed by 8.2% to $442.40 per share while the index has gained 11.5%.
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Why Do We Think Tesla Will Underperform?
We're cautious about Tesla. Here are three reasons there are better opportunities than TSLA and a stock we'd rather own.
1. Demand Slips as Sales Volumes Slide
Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Automobile Manufacturing company because there’s a ceiling to what customers will pay.
Tesla’s units sold came in at 358,023 in the latest quarter, and they declined by 3.3% annually over the last two years. This performance was underwhelming and implies there may be increasing competition or market saturation. It also suggests Tesla might have to lower prices or invest in product improvements to grow, factors that can hinder near-term profitability. 
2. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Tesla’s margin dropped by 4 percentage points over the last five years. Continued declines could signal it is in the middle of an investment cycle as it pursues new AI technologies such as a robotaxi or humanoid robot fleet. Tesla’s free cash flow margin for the trailing 12 months was 7.2%.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. While Tesla’s ROIC fell recently due to its price cuts, the broader trend is still healthy as its ROIC is higher than a few years ago. This is because it’s investing aggressively to capture the AI opportunity. Only time will tell if these investments bear fruit in higher long-term ROICs.
Final Judgment
Tesla falls short of our quality standards. That said, the stock currently trades at 207× forward price-to-earnings (or $442.40 per share). This valuation tells us a lot of optimism is priced in - we think there are better stocks to buy right now. We’d suggest looking at one of our top software and edge computing picks.
Stocks We Like More Than Tesla
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