Is the Tesla share price rise justified?

Baillie Gifford funds have been among the beneficiaries of a sharp rise in Tesla shares. Rob Morgan looks at one of their manager’s views on the company.

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  1. Rob Morgan

How can a company yet to make an annual profit be the world’s second most valuable auto maker? The electric car firm is only eclipsed by Toyota in terms of its stock market valuation, and it’s now worth more than twice as much as Ford and General Motors, two profitable US auto giants, combined.

Many investors are questioning whether the quadrupling in Tesla shares over the past four months is rational, or whether the shares simply been driven higher by speculators or the FOMO (‘fear of missing out’) effect. Others point to a ‘short squeeze’. This where investors aiming to profit from an anticipated fall in price are forced to reverse their stance, and buy as shares rise in order to limit losses.

For sure, there’s been some recent good news that have helped spark the rally. Rising sales, plans for a factory in China and a second quarter of modest profits. Yet the value of Tesla is more about where the company is going, not where it is now, and that is not easy to assess. Given the car maker could either be front and centre of the electric vehicle (EV) revolution or just one of the pack of manufacturers aiming to take a slice of the space, the range of outcomes is exceptionally wide. That means investor sentiment can swing around considerably – and so can the share price. Doubters think the current valuation is ridiculous – or at least well ahead of itself. Meanwhile, believers point out the firm has a technological edge and is building a unique infrastructure that will dominate the EV landscape.

One of Tesla’s biggest backers

Few fund managers in the UK have benefited from the recent meteoric rise in Tesla shares. A small number of sustainability-themed funds and a couple specialising in artificial intelligence hold the stock, but among the most longstanding holders have been investments in Baillie Gifford’s range including Scottish Mortgage Investment Trust and Baillie Gifford Positive Change Fund, where it is now the largest holding. Both are constituents of our Foundation Fundlist.

Baillie Gifford is well known for its long-term approach of backing companies using technological advances to reshape the world and what is possible in the future. The Edinburgh-based firm are big backers of Tesla, holding 10% of the company’s shares in total. The managers remain long term believers, feeling that the recent price surge is to some extent recognition of the operational progress the company has been making for some time. According to co-manager of Scottish Mortgage, Tom Slater, the most recent results (January 2020) highlight continued positive developments, and that the business is in a strong position.

Perhaps then the market has woken up to some of the virtues of Tesla? Mr Slater states it is, “Extremely difficult to divine” why the share price has risen so quickly in a short space of time. Certainly, there is greater investor interest in sustainable forms of energy generation and usage, but he cautions against spending much time trying to interpret or predict short term share price movements. The Baillie Gifford managers are sticking to evaluating the fundamental position of the business and whether the shares look attractive in that context. Their conclusion at present is that they do.

The road ahead

Mr Slater points out that the fundamental process behind their strategy is, “Identifying exceptional growth businesses with large opportunities and something about the business that will allow it to capitalise on that opportunity”. To him, the information coming from Tesla over the past year makes them more confident that it can capitalise on the EV opportunity, not least because it is successfully executing its plans. He points to new manufacturing capacity in China and bringing a new model, the small SUV Model Y, to the market ahead of schedule as examples.

Meanwhile, Mr Slater has seen some reassuring signs on demand, for instance, the launch of Tesla’s pickup truck has attracted a high number of orders in a very short space of time. There is also growing evidence that if electric vehicles are offered at a similar price to an equivalent combustion engine vehicle, there is a lot of demand. He believes Tesla can get to this point well before the competition as he as seen very limited progress from elsewhere in the industry. “Others are very clearly struggling to achieve scale in the production of electric vehicles and so the relative position of Tesla has continued to improve”, he states.  

With more confidence about the scale of the opportunity and about Tesla's ability to capitalise on it, it is not surprising to Mr Slater that the market is increasingly prepared to value Tesla higher. He is resisting the urge to make knee-jerk reactions to short-term share price movements, content that the scale of the opportunity in the move to electric transport, autonomous vehicles and the deployment of storage in electricity grids is substantial relative to the current value of the company.

A long-term view through the ups and downs

The price, of course, is short term volatility and its effect on fund performance. If Tesla shares give back a portion of gains, then the Baillie Gifford funds holding them will suffer. However, it’s clear that Baillie Gifford managers are taking a patient, long-term view and are resolved to maintain exposure for the time being. It is worth noting, though, that Baillie Gifford Positive Change Fund, run by a separate team to Scottish Mortgage, has a restriction that limits a holding in a single stock to a maximum of 10% of the portfolio. Accordingly, the managers have been forced to trim back their Tesla shareholding to keep within this limit.

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