Nobody wants to miss a huge opportunity, and it’s pretty clear that electric vehicles are going to be a huge opportunity indeed. But the fear of missing out (or FOMO as kids say these days) shouldn’t get you to the point where you make an investment mistake. This is how conservative investors should probably think about electric vehicle (EV) stocks today.
Survival bias
We all know the names of the major automakers, including such as ford, Toyota, and Volkswagen, among other. The list of giants is actually pretty small, but when internal combustion engine cars only just hit the market, a lot more names were battling it out for supremacy. What we see today are the ones who managed to survive and thrive the early chaotic days of an emerging industry. The same story holds true one industry after another, with an onslaught of early players that eventually shook out small numbers of big winners.
Image source: Getty Images.
This is a big problem for investors. First of all, the winners can be fantastic investment opportunities. So there is reason to be happy when new industries emerge. Second, and perhaps more importantly, figuring out which companies will actually emerge as winners can be difficult. Yahoo! and AOL are examples on the Internet of former industry leaders who eventually became followers.
These two facts often lead Wall Street, in its exuberance, to bid up the prices of many stocks in an emerging sector, even though most will not prove to be good investments in the long run. This is exactly what is happening with electric vehicle stocks today.
Some numbers
Tesla (NASDAQ: TSLA), the flagship of electric vehicle stocks, is a good example. There is no question about the important role this company played in developing the EV market. However, it currently has a market cap of around $ 660 billion. Ford has a market capitalization of $ 58 billion General Motors at $ 85 billion. It’s hard to believe that Tesla’s business is really worth eleven times as much as Ford’s, or about eight times as much as GM’s.
To be fair, Tesla is probably the most extreme example you can find, given the massive hype surrounding the company and its attention-loving CEO. But even the less egregious examples are still troubling. To take NOK (NYSE: NIO), which has a market capitalization of around $ 75 billion. While the company’s deliveries rose significantly year over year in the first quarter, from around 4,000 vehicles in 2020 to 20,000 this year, the company is still losing money. Ford, GM, and Tesla were all profitable. Investors are clearly offering NIO a valuation on par with large and profitable automakers, but that is driven by hope for future results, not what the company’s financial statements show today.
There are other names in the industry that haven’t received the same eye-catching reviews in the market. Specifically, Nikola, Lordstown Motors, and Workhorse group, with market capitalizations of $ 6 billion, $ 1.6 billion and $ 1.6 billion, respectively. Like NIO, however, the bottom line is that they are all bleeding red ink and none have reached the scale of operations that Tesla and the traditional automakers have achieved. That said, Nikola is a terrifying case for the valuation extremes that can take shape, given that its market cap was around $ 25 billion at the end of 2019 and is now only about $ 6 billion (there are company-specific reasons for this, but that does not change the volatility of the share price).
TSLA price-book value data from YCharts
However, market capitalization is not a really good valuation tool. This is why it’s so important to remember that most of the EV stocks mentioned above are not profitable. Basically, without the profit, you cannot use the price / earnings ratio, the most traditional valuation metric, as a reference point. However, you can use price-to-book value (P / B), which studies market valuation in relation to balance sheet metrics. As the graphic above shows, all of the above EV names have a higher P / B ratio than GM or Ford, despite the fact that they don’t have nearly the same industry position or business size.
Shake out
As mentioned earlier, it is not uncommon in emerging industries for investors to skyrocket many stocks in hopes of finding some big winners. So it’s really not shocking that EV stocks are being favored over more traditional automakers. However, it is very clear that EV stocks look expensive when compared to the broader auto industry. Which is important because the older names in the room quickly reach into the EV room; and they have manufacturing and distribution infrastructure that pure EV names generally lack.
In other words, the EV space will be competitive and it is not clear which, if any, pure EV names will come out on top. For anyone with a conservative or value-conscious investment style, it’s hard to see EV stocks as excessive compared to their actual business performance at the time.
This article represents the opinion of the author, which may not agree with the “official” recommending position of a world class Motley Fool advisory service. We are colorful! Questioning an investment thesis – even one of our own – helps us all think critically about investing and make decisions that will help us get smarter, happier, and richer.
