Wednesday, December 15, 2021

Back in the Classroom: Time to Teach!

At the start of every semester for as long as I can remember, I have invited people to sit in informally on my classes at NYU or take the shorter online versions on my website. After thirty six years of teaching, you would think I would be jaded, but I am not. As we get ready for the spring, I am excited, perhaps more so than usual, because I hope to finally be in a real classroom, instead of online, for my classes. 

Spring is here, and the classroom beckons!

    I have always described myself as a teacher, first and foremost, but like many of you, COVID has been a disruptor. For much of the last two years, rather than teach my classes in a classroom, I taught my classes from my home office, making a few low-cost, low-tech investments to improve my set up. 

I know that many of us, especially as we age, take the dystopian view that technology has hurt more than helped, and while I share the concern about the damage that social media has wrought on society, I remain thankful for the good that has come from technological advances. The combination of speedy internet access and delivery platforms (Zoom, Teams, Skype, Blue Jeans etc.) allowed me to deliver my classes from home, with some help. With a M1 MacBook Pro, a 27 inch LG display and my iPad Pro in sidecar mode, I could see everyone in my class, albeit with some work; with Zoom, the limit was 48 students at a time. My Rode Go lav mike and my AirPods Pro, took care of my audio needs, and my Logitech C920 camera supplemented my computer's camera to cover my video requirements, with two extra spotlights for late evening sessions, when natural light failed. To top it all off, and this was priceless, I could see the Pacific Ocean, out of my window, especially when I was able to teach standing, using my Flexispot standing desk to elevate my monitor. (If you are wondering why I have been so specific about my accessories, it is not because I receive sponsorship payments from any of these companies, but because it may help you replicate my set up, other than the view of the Pacific, if you are teaching or working from home. If you have a bigger budget, I would try to emulate Professor Andrew Lo, who described his astounding set up for teaching last year.)

     In these last two years, I have learned a lot about online teaching and I hope that learning makes me a better teacher, both online and in the classroom. 

  • First, with today's technology, online classes get scarily close to physically being in a classroom, a reminder to me, and teachers all over the world, that unless we offer something unique in a classroom setting, disruption is coming for the teaching business. 
  • Second, I learned there is some learning that is better delivered online, than in a physical setting, and I believe that there are some topics that I will continue to deliver online, even after this virus passes on. 
  • Third, while I still loved teaching online, I desperately missed the feeling of being in an actual classroom, looking at a collection of faces, some with eyes closed, some bored and some waiting to ask a question. After all, every teacher is a repressed actor, and actors draw their energy from their audiences, and I have been missing mine!

Each semester, I step into a classroom wanting to teach the “best” class that I ever have, perhaps even the perfect class, knowing fully well that I will fall short, in practice, because there will be things to improve.


    I am a dabbler, not a specialist, and my teaching reflects that predisposition. During my teaching lifetime, I have taught a wide swath of classes, ranging from banking to equity instruments, but in the last twenty years, my focus has been on three classes, corporate finance, valuation and investment philosophies, with the last one taught only online. My classroom teaching at Stern has been mostly corporate finance and valuation, to both MBAs and undergraduates. With MBAs, the corporate finance class has been a first year elective and the valuation has been an elective in the second year, and with undergraduates, I have alternated between the two classes across the years. I have added shorter online versions of each class, offered on my website, at no cost, but with no credit. Starting a few years ago, Stern has offered certificate versions of each of the three classes, albeit at a price, but with more structure (quizzes, exams, projects) and a certificate, if you make it through. 

Pre-Game Prep

    In all of my regular classes, I have drawn on the assumption that my students come in with an exposure and understanding of three areas, accounting (more in the context of being able to read financial statements than the mechanics of debit and credit), basics of finance (especially the time value of money and an understanding of markets) and statistics (how to make sense of data). Being a control freak, I have created my own versions of what I would like my students to know in each of these disciplines, and you can find my versions on my website. With each of my classes, I am sure that purists in each of these areas would blanch not just at my choice of topics that matter, but also at my sloppiness in description, but I will let you be the judge of content.

    The place to start is with accounting. Much as I abuse accountants in my classroom, I also recognize that almost all of the raw material we use in corporate finance and valuation comes from accounting statements. Put simply, if you cannot tell the difference between operating and net income, or what to consider as debt, you will be lost in any type of financial analysis. In my eleven-session (with each session lasting 15-20 minutes) accounting class, I cover the material that I draw on in my finance classes:

Web page for class

Once you have the accounting basics under your belt, you can turn to the basics of finance. The time value of money is at the heart of almost everything in finance, and understanding the mechanics and intuition of present value is a bedrock on financial analysis. In my introductory finance class, I cover the time value of money, and how risk plays out in that computation, as well as look at three macro variables that we encounter repeatedly in financial analyses - inflation, interest rates and exchange rates.

Web page for class

Finally, we live in the age of data, and it is surprising that we use that data so little, and when we do, so badly. If the role of statistics is to make sense of large and contradictory data, it is a critical skill in every discipline, and especially one, with as many numbers as finance. With the full disclosure that I am a statistical novice, I put together a statistics class, purely as a user of its many tools, and in 13 sessions,  I cover everything from descriptive statistics to multiple regressions and simulations.

Web page for class

If you are well versed in accounting, statistics and the basics of finance, you may find the material in these classes simplistic, but it never hurts to reinforce existing concepts.

The Game

    If you have the pre-game behind you, it is time to turn to the main attractions (or tortures, depending on your perspective), and I will present them in the sequence that I think it makes the most sense to take them, if you want to torture yourself by taking all three. 

a. Corporate Finance

    If you have taken a corporate finance class in your past life, you may be surprised by what I cover, and what I do not, in my corporate finance class. My version of the class should have a different name, since it is not just about corporations and I am not sure that it is all about finance either. It covers the first financial principles that govern how to run a business, and as a consequence, it has the broadest reach and the deepest impact of any of my classes. Whether you are an entrepreneur, starting on the long process of converting an idea into a business, a manager, evaluating how to make business decisions consistently or a consultant, offering advice on what a business should do differently, corporate finance is your go-to class, since it offers guiding principles for all your tasks. I start the class with a one-page summary of the entire class:

Web page for class
As you can see from the coverage, everything that happens in business is fair game in a corporate finance class, from whether ESG adds or detracts from value, why companies are shifting from paying dividends to buying back stock and how corporate tax changes can affect financing decisions. It is also, in every sense of the word, an applied class, with every concept applied to real companies that range the spectrum, across the life cycle, geographies and sectors.

   I will be teaching this class to Stern MBAs, starting on January 31, 2022, meeting every Monday and Wednesday, from 10.30 am - 11.50 am, New York time, through May 9, 2022. If you are a Stern MBA, you are welcome to take the class, but if you are not, you can take the class informally, by watching the recorded sessions at this link, taking the quizzes and exam, if you are up for them, and even tracking the emails that I send the class at this link. Since the 26 sessions of the class are 80 minutes apiece, this will require a substantial investment in time, though no investment in money, albeit with no certification or credit. If that time investment is too much of a burden, I have created an online version of the class here, with 15-minute sessions replacing the longer classroom sessions, and while they will cost you nothing as well, they come with no certification. If certification is your end game, and I understand that it may help augment a resume, you can take the NYU version of the online class in the fall of 2022, with a more polished interface and personal interaction, but the same content, where you will get a certification and NYU will get a portion of your savings. 

b. Valuation 

    My valuation class starts with an ambitious agenda, i.e., to give you the tools and techniques to value or price just about anything, from bitcoin to collectibles to infrastructure projects, and from any perspective, from a potential buyer to an accountant estimating fair value. 

Web page for class

Along the way, I emphasize what I believe to be long standing truths about valuation. First, it is a craft, not an art or a science, and you get better at valuation by doing, not by reading or watching others do valuation. Second, while there are many practitioners and academics who use the words value and price interchangeably, the value and pricing processes are not only driven by different determinants, but also can yield different numbers for the same asset. Third, while valuations ultimately are collections of numbers, those numbers lose their resonance and meaning, if they are not connected to narratives that tie these numbers together.

    This class will be taught to two different audiences, Stern MBAs, many of whom were in my corporate finance class last spring, and Stern undergraduates, mostly juniors. While the first group will meet every Monday and Wednesday, from 1.30 pm - 2.50 pm, from January 31, 2022, to May 9, 2022, and the second will meet every Monday and Wednesday from 3.30 pm - 4.45 pm, from January 24, 2022, to May 9, 2022, the classes are identical in content and delivery. You are welcome to unofficially partake in either of these classes, both in recorded form, but as with corporate finance, you can take an online version of the valuation class, with twenty six shorter (15-minute) sessions, for free, with no certification, on my site, or for a price and a certificate from NYU.

c. Investment Philosophy

    This class has its origins in a seminar class that I was asked to teach more than twenty years ago, where successful investors would come in each session and talk about what they did in investing that made them successful. As we transitioned from technical analysts to value and growth investors to market timers, each of whom was successful, albeit with wildly different views of markets and divergent paths to success, I concluded that there could not be one template for investment success, and started looking at not only differences in investment philosophies, but also what personal qualities made for success, with each one. That led to a book, and then to a class on investment philosophies, where I cover the range of choices.

Web page for class

If there are two lessons that I hope that people take away from this class, it is (a) that no investment philosophy, no matter how storied and successful it has been in the past, has a monopoly on investment virtue and that (b) the right investment philosophy for you is the one that best fits your personality and strengths. 

    While I do not teach this course in a classroom, there are two ways you can take the class. One is online, on my website, where I lead you through a journey through different investment philosophies, weighing not just past successes, but also the combination of factors that you need to have to succeed each one, over the course of 36 sessions. As with the other online classes on my site, it is free, but without certification. If you do want certification, there is the NYU version of the class available here, but for a price (that I do not set or control... so it is not fair to argue its fairness or unfairness with me).

Game Plan

    While I hope that the descriptions of the classes will help you decide which of these courses best fits you, you may still be confused about the choices and the sequence. I hope that the flow chart below provides a little more clarity:

Web page for all classes
As you can see, if your end game is financial decision making within a business, as owner or employee, the corporate finance class will do, whereas if your intent is to learn the skills of appraising value, either for accounting/regulatory or transaction purposes, adding valuation will augment your tool kit. Finally, if you are an investor in companies, and are uninterested in the mechanics of value, you can go directly to the investment philosophies class, or make an intermediate stop, and take a look at valuation.

    Each time I present these choices, I will always have a few people demand to know my investment record, and with respect, I will refuse, for two reasons. First, there is nothing in my track record, whether positive or negative, that will help you assess whether what I talk about has heft, since luck is the dominant factor in any investor's track record, even over long periods. Second, this demand would make complete sense, if I were seeking to manage your money, which I am not, or promising you investment riches, which I am also not. If this absence of proof is a deal breaker for you, I understand, but if it is, trust me when I say that these are not the droids classes that you were looking for. My classes may not make you richer or wiser, but I hope that they give you a fresh perspective on finance and markets and the confidence to question what others contend to be truths. May the force be with you!

YouTube Video

Class List

  1. Accounting for finance and investing (My webpage, YouTube Playlist)
  2. Foundations of Finance (My webpage, YouTube Playlist)
  3. Statistics for finance and investing (My webpage, YouTube Playlist)
  4. Corporate Finance (Spring 2022 MBA Class, Free Online, NYU Certificate in Fall 2022)
  5. Valuation (Spring 2022 MBA Class, Spring 2022 Undergraduate Class, Free Online, NYU Certificate)
  6. Investment Philosophies (Free Online, NYU Certificate)

Friday, December 10, 2021

Managing across the Corporate Life Cycle: CEOs and Stock Prices!

One of the big news stories of last week was Jack Dorsey stepping down as CEO of Twitter, and the market's response to that news was to push up Twitter's stock price by almost 10%. That reaction suggested, at least for the moment, that investors believed that Twitter would be better off without Dorsey running it, a surprise to those in the founder-worship camp. As the debate starts about whether Dorsey's hand-picked successor, Parag Agrawal, is the right person to guide Twitter through its next few years, I decided to revisit a broader question of what it is that makes for a "great CEO" and how there is no one right answer to that question, because it depends on the company, and where it stands in its life cycle. In the process, I will also look at the thorny issue of what happens when there is a mismatch between a company and its CEO, either because the board picks the wrong candidate for the job or because the company has changed over time, and the CEO has not. Finally, I will use the framework to look at the relationships between founders and their companies, and how mishandling management transitions can have damaging, perhaps even devastating, consequences for value.

The "Right" CEO: A Corporate Life Cycle Perspective

   The notion that there is a collection of characteristics that makes a person a great CEO for a company, no matter what its standing, is deeply held and fed into by both academics and practitioner. In this section, I will begin by looking at the mythology behind this push, and why it does not hold up to common sense questioning. 

The Mythology of the Great CEO

    Are there a set of qualities that make for a great CEO? To answer the question, I looked at two institutions, one academic and one practice-oriented, that are deeply invested in that idea, and spend considerable time advancing it. 

  • The first is the Harvard Business School, where every student who enters the MBA program is treated as a CEO-in-waiting, notwithstanding the reality that there are too few openings to accommodate that ambition. The Harvard Business Review, over the years, has published multiple articles about the characteristics of the most successful CEOs, and this one for instance, highlights four characteristics that they share in common: (a) deciding with speed and conviction, (b) engaging for impact with employees and the outside world (c) adapting proactively to changing circumstances and (d) delivering reliably.
  • The second is McKinsey, described by some as a CEO factory, because so many of its consultants go on to become CEOs of their client companies. In this article, McKinsey lists the mindsets and practices of the most successful CEOs in the following picture: 

Given how influential these organizations are in framing public perception, it is no surprise that most people are convinced that there is a template for a great CEO that applies across companies, and that boards of directors in search of new CEOs should use this template. 
    That perspective also gets fed by books and movies about successful CEOs, real or imagined. Consider Warren Buffett, Jack Welch and Steve Jobs, very different men who have been mythologized in the literature, as great CEOs. Many of the books about Buffett read more like hagiographies than true biographies, given how star struck the writers of these books are about the man, but by treating him as a deity, they do him a disservice. The fall of GE has taken some of the shine from Jack Welch's star, but at his peak, just over a decade ago, he was viewed as someone that CEOs should emulate. With Steve Jobs, the picture of an innovative, risk-taking disruptor comes not just from books about the man, but from movies that gloss over his first, and rockier, stint as founder-CEO of Apple in the 1980s.
    The problem with the one-size-fits-all great CEO model is that it does not hold up to scrutiny. Even if you take the HBR and McKinsey criteria for CEO success at face value, there are three fundamental problems or missing pieces. First, even if all successful CEOs share the qualities listed in the HBR/McKinsey papers, not all people or even most people with these qualities become successful CEOs. So, is there a missing ingredient that allowed them to succeed? If so, what is it? Second, I find it odd that there are no questionable qualities listed on the successful CEO list, especially given the evidence that over confidence seems to be a common feature among CEOs, and that it is this over confidence that allows them to take act decisively and adopt long term perspectives. When those bets, often made in the face of long odds, pay off, the makers of those bets will be perceived as successful, but when they do not, the decision makers are consigned to the ash heap of failure. Put simply, it is possible that the quality that binds together successful CEOs the most is luck, a quality that neither Harvard Business School nor McKinsey can pass on. Third, there are clearly some successful CEOs who not only do not possess many of the listed qualities, but often have the inverse. If you believe that Elon Musk and Marc Benioff, CEOs of Tesla and Salesforce, are great CEOs, how many of the Harvard/McKinsey criteria would they possess?

The Corporate Life Cycle

    I believe that the discussion of what makes for a great CEO is flawed for a simple reason. There is no one template that works for all companies, and one way to see why is to bring in the notion that companies go through a life cycle, from start-ups (at birth) to maturity (middle age) to decline (old age). At each stage of the life cycle, the focus in the company changes, as do the qualities that top managers have to bring for success:

Early in the life cycle, as a company struggles to find traction with a business idea that meets an unmet demand, you need a visionary as a CEO, capable of thinking outside the box, and with the capacity to draw employees and investors to that vision. In converting an idea to a product or service, history suggests that pragmatism wins out over purity of vision, as compromises have to be made on design, production and marketing to convert an idea company into a business. As the products/services offered by the company scale up, the capacity to build businesses becomes front and center, as production facilities have to be built, and supply chains put in place, critical for business success, but clearly not as exciting as selling visions. Once the initial idea has become a business success, the needs to keep scaling up may require coming up with extensions of existing product lines or geographies to grow, where an opportunistic, quick-acting CEO can make a difference. As companies enter the late phases of middle age, the imperative will shift from finding new markets to defending existing market share, in what I think of the trench warfare phase of a company, where shoring up moats takes priority over new product development. The most difficult phase for a company is decline, as the company is dismantled and its sells or shuts down its constituent parts, since any one who is put in charge of this process has only pain to mete out, and bad press, to go with it. Have you ever read a book or seen a movie about a CEO who shrunk his or her company, where that person is painted as anything but a villain? In fact, I used "Larry the Liquidator" as my moniker for that CEO, to pay homage to one of my favorite movies of all time, "Other People's Money":


As you watch the video, note that the CEO of the company, under activist attack, is played by Gregory Peck (the distinguished gray-haired gentleman who sits down at the start of the video), who presumably embodies all the qualities that Harvard and McKinsey believe embody a great CEO, and Danny DeVito plays "Larry the Liquidator". Talk about type casting, but this company needs more DeVito, less Peck!

Mismatches, Transitions and Turnover

    If you buy into my structure of a corporate life cycle, and how the right CEO for a company will change as the company ages, you can already see the potential for mismatches between companies and CEOs, for three reasons. 

  • A Hiring Mistake: The first is that the board of directors for a company seeking a new CEO hires someone who is viewed by many as a successful CEO, but whose success came at a company at a very different stage in its life cycle. I think Uber dodged the bullet in 2017, when they decided not to hire Jeff Immelt as CEO for the company. Even if you had believed that Immelt was successful at his prior job as CEO for GE, and that is arguable, he would have been a horrifically bad choice as CEO at Uber, a company that is as different from GE as you can get, in every aspect, not just corporate age. 
  • A Gamble on Rebirth: The second is when a board of director picks a mismatched CEO intentionally, with the hope that the CEO characteristics rub off on the company. This is often the case when you have a mature or declining company that thinks hiring a visionary as a CEO will lead to reincarnation as a growth company. While the impulse to become young again is understandable, the odds are against this gamble working, leaving the CEO tarnished and company worse off, in the aftermath. It was the reason that Yahoo! hired Marissa Mayer as a CEO in 2012, hoping that her success at Google would rub off on the company, an experiment that I argued would not end well for either party (and it did not).
  • A Changing Business; The third is a more subtle problem, where a company is well matched to its CEO at a point in time, but then evolves across the life cycle, but the CEO does not. Using the Uber example again, Travis Kalatnick, a visionary and rule breaker, might have been the best match for Uber as a company, in early years, when it was disrupting a highly regulated business (taxi cabs), but even without his personal missteps, he was ill-suited to a company that faced a monumental task of converting a model built on acquiring new riders into one that generated profits in 2017.
In NY case, a CEO/company mismatch is a problem, though the consequences can range from benign to malignant. 
In the most benign case, a mismatched CEO recognizes the mismatch, sets ego aside and finds a partner or co-executive with the skills needed for the company. In my view, and many of you may disagree with me, the difference between the first iteration of Steve Jobs, where he let his vision run riot and almost destroyed Apple as a company, and the second iteration, where he led one of the most impressive corporate turnarounds in history, was his choice of Tim Cook as his chief operating officer in his second go-around and his willingness to delegate operating authority. In short, Jobs was able to continue to put his visionary skills to work, while Cook made sure that the promises Jobs made were delivered as products on the ground. In the most malignant form, a badly mismatched CEO is entrenched in his or her position, perhaps because the board of directors has become a rubber stamp or by tilting voting rules (shares with different voting rights) in favor of incumbency, and continues on a pathway that takes the company to ruin. In the intermediate case, the board of directors, perhaps with a push from activist investors and large stockholders, engineers a CEO change, albeit after some or a great deal of damage has been done.

The Compressed Life Cycle: Implications for Founder CEOs

    It is a testimonial to how much technology companies have changed the economy and the market that some of the best-recognized names in business are those of the founders of successful technology company. I would wager that almost everyone has heard of Bill Gates, Jeff Bezos and Elon Musk, and that very few would recognize the names of Mary Barra (CEO of GM) or Darren Woods (CEO of Exxon Mobil). While there are some who venerate these founders, in what can only be called founder worship, there are others who have a more jaundiced view of them, both as human beings and as CEOs. The corporate life cycle framework provides a useful structure to think about how the technology companies, that dominate the twenty first century business landscape, are different from the manufacturing companies of the last century, and why these differences can create more management tensions at these companies.

Aging in Dog Years?

    While every company goes thought the process of starting up, aging and eventually declining, the speed at which it does will vary depending on the business it is in. More specifically, the more capital it takes to enter a business and the more inertia there is among the existing players (producers, customers) are, the longer it will take for a company to get from start up to mature growth, but the same forces will play out in reverse, allowing the company to stay mature for a lot longer and decline a lot more gradual:

The great companies of the twentieth century took decades to ramp up, facing big infrastructure investments and long lags before expansion, had long stints as mature firms, milking cash flows, before embarking on long and mostly gradual declines. To illustrate, Sears and GE had century-long runs as successful companies, before time and circumstances caught up with them, and GM and Ford struggled for three decades setting up manufacturing capacity and tweaking their product offerings, before enjoying the fruits of their success. In contrast, consider Yahoo!, a company that was founded in 1994, that managed to reach a hundred billion in market capitalization by the turn of the century, enjoyed a few years of dominance, before Google's arrival and conquest of the market, before finally being acquired by Verizon in 2017. This compression of the life cycle has played out in tech company after tech company and the graph below captures the difference:

In short, tech companies age in dog years, with a 20-year tech company often resembling a hundred-year old manufacturing company, with creaky business models and facing disruption.

Implications for Founder CEOs and Management Turnover

    Companies have always had founders, and while the conflict between founders and others in the company have been around for decades, the compressed life cycle has exacerbated these tensions and magnified problems. In particular, the research on founder CEOs has yielded two disparate findings. The first is that in the early stages of companies, founder CEOs either step down or are pushed out at much higher rates than in more established companies. The second is that those founder CEOs who nurse their companies to more established status, and to public offerings, are more entrenched that their counterparts at mature companies.

    To understand the first phenomenon, i.e., the high displacement rate among founder CEOs of very young companies, I will draw on the work of Noah Wasserman at Harvard Business School who has focused intensively on this topic. Using data on top management turnover at young firms, many of them non-public, he concludes that almost 30% of CEOs at these firms are replaced within a few years of inception, usually at the time of new product development or fresh financing. Much of this phenomenon can be explained by venture capitalists, with large stakes, pushing for change in these companies, but a portion of it is voluntary, and to explain why a founder CEO might willingly step down, Wasserman uses the concept of the founder's dilemma, where founders trade off full control of a much less valuable firm (with themselves in control) for lesser control of a much more valuable firm (with someone else at the helm). In the corporate life cycle structure, it is a recognition on the part of founders or capital providers that the skills needed to take a company forward require a different person at the top of the organization, especially as a firm transitions from one stage of the life cycle to the next.

    The founders who do manage to stay at the helm of companies that make it through to early growth status are put on a pedestal, relative to CEOs of established companies. While that may be understandable, in some cases, it can take the form of founder worship, where founders are viewed as untouchable, and any challenge to their authority is viewed as bad, leading to efforts to change the rules of the game to prevent these challenges. In the United States, where prior to 2004, it was unusual to see shares with different voting rights in the same firm, it is now more the rule than the exception in many tech companies. 

    Endowing CEOs with increased powers to fend off challenges seems like a particularly bad idea at tech companies, since their compressed life cycles are likely to create more, rather than less, mismatches between companies and their founder/CEOs, and sooner, rather than later. To see, why consider how corporate governance played out at Ford, a twentieth century corporate giant. Henry Ford, undoubtedly a visionary, but also a crank on some dimensions, was Ford's CEO from 1906 to 1945. His vision of making automobiles affordable to the masses, with the Model T, was a catalyst in Ford's success, but by the end of his tenure in 1945, his management style was already out of sync with the company. With Ford, time and mortality solved the problem, and his grandson, Henry Ford II, was a better custodian for the firms in the decades that followed. Put simply, when a company lasts for a century, the progression of time naturally takes care of mismatches and succession. In contrast, consider how quickly Blackberry, as a company, soared, how short its stay at the top was and how steep its descent was, as other companies entered the smart phone business. Mike Lazaridis, one of the co-founders of the company, and Jim Balsillie, the CEO he hired in 1992 to guide the company, presided over both its soaring success, gaining accolades for their management skills for doing so, and over its collapse, drawing jeers from the same crowd. By the time, the change in top management happened in 2012, it was viewed as too little, too late.

    In my view, the next decade will bring forth more conflict, rooted in the compressed life cycle of companies. If I were a case study writer, and thank God I am not, I would not rush to write case studies or books about successful tech company CEOs, because many of those same CEOs will become case studies of failure within a few years. If I am an investor, I would worry more than ever before about giving up voting power to founder/CEOs, even if they are well regarded, because today's star CEO can become tomorrow's problem. I wonder whether the way Facebook has dealt with its privacy and related problems over the last few years would have been different, if investors had not allowed Mark Zuckerberg to effectively control 57% of the voting rights with less than 20% of the outstanding shares. It is worth noting that Twitter was one of the few social media companies that chose not to split its voting rights across shares, and that may explain the Jack Dorsey departure.

Implications for Investors
   I have long argued that when investing in young tech companies, you are investing in a story about the company, not an extrapolation of numbers.  The compressed corporate life cycle, and the potential for CEO/company mismatches that it creates, adds a layer of additional uncertainty to valuation. In short, when assessing the value of a young company's story, you are also assessing the capacity of the management of the company to deliver on that story. To the extent that the founder is the lead manager, and the narrative-setter, any concerns you have about the founder's capacity to convert that story into business success will translate into lower value. Let me illustrate using three examples, the first being Amazon in my early valuations of the company between 1997 and 2000, the second being Twitter, especially in the context of Jack Dorsey's departure and Paytm, the Indian online company, whose recent IPO was a dumpster fire.
  • I have always liked Amazon, as a company, and one reason for that was Jeff Bezos. Many younger investors are surprised when I tell them that Bezos was not a household name for much of Amazon's early rise, and that it was The Washington Post acquisition in 2013 that brought him into public view. One reason that I attached lofty values to Amazon as a company, even when it was a tiny, money-losing company was that Bezos not only told the same story, one that I described as Field of Dreams story, where if you build it (revenues), they (profits) will come. but acted consistently with that story. He built a management team that believed that story and trusted them to make big decisions for the company, thus easing the transition from small, online book retailer to one of the largest companies in the world. It is a testimonial to Bezos' success in transitioning management that Amazon's value as a company today would be close to the same, with or without him at the helm, explaining why the announcement that he was stepping down as CEO on July 5 created almost no impact on the stock price.
  • I valued Twitter for the first time, just ahead of its IPO in 2013, and built a model premised on the assumption that the company would find a way to monetize its larger user base and build a consistently money-making enterprise. In the years since, I have been frustrated by its inability to make that happen, and in this post in 2015, I laid the blame at least partially at the feet of Twitter's management, contrasting its failure to Facebook's success. I don't know Jack Dorsey, and I wish him well, but in my view, his skill set seemed ill suited to what Twitter needed to succeed as a business, especially as he was splitting his time as Square's CEO, and talking about taking a six-month break in Africa.  In fact, eight years after going public, Twitter's strongest suit remains that it has lots of users, but its capacity to make money of these users is still questionable. One reason why the market responded so positively, jumping 10% on the news that Dorsey was leaving, is indicative of the relief that change was coming, and the reason that it has fallen back is that it is not clear that Parag Agrawal has what the company needs now. He has time to prove investors wrong, but he is on probation, as investors look to him to reframe Twitter's narrative and start delivering results.
  • A few weeks ago, I valued one of India's new unicorns, Paytm, an online payment processing company built on the promise of a huge and growing online payment market in India. In my valuation, I told an uplifting story of a company that would not only continue to grow its user base and services, but also that it would increase its take rate (converting users to revenues) and benefit from economies of scale to become profitable over the course of the next decade.

    I valued Paytm at about 2,200, but in telling that story, I noted one big area of concern with existing management, that seemed to be more intent on adding users and services than on converting them into revenues, and pre-disposed to grandiosity in its statement of purpose and forecasts. In the months since, the company has gone public, and while the offering price, at 2150, was close to my value, the stock price collapsed in the days after to less than 1400 and has languished at about 1600-1700 since. It is always dangerous to try to explain why markets do what they do over short periods, but I do think that the company's founders and spokespeople did not do themselves any favors, ahead of the IPO. Specifically, if you were concerned about Vijay Sharma's capacity to convert the promise of Paytm into eventual profits, before the IPO, you would have been even more concerned after listening to him in the days leading into the IPO. It is still too early to conclude that there is a company/CEO mismatch, but if I were top management of the firm, I would talk less about users and gross merchandise value, and focus more on improving the abysmally low take rate at the firm. 
If there is a general lessons for investors from this post, it is that when a founder CEO leaves his position, or is pushed out, the value change can be positive or negative, and that  good founders will work at making themselves less central to their company's stories over time and thus less critical to its value. It should also be a cautionary note for those investors who have looked the other way as venture capitalists, founders and insiders have fixed the corporate governance game in their favor, in young tech companies that go public, ensuring that mismatches from companies and CEOs, if they occur in the future, will persist. 

Family Group Companies: The Life Cycle Effect
    In much of the world, businesses, even if they are publicly traded, are run by family groups. To the extent that the top management of these businesses are members of the family, these companies are uniquely exposed to company/CEO mismatches, especially as second or third generations of a family enter the management ranks, and these families enter new businesses.

Family Group Companies: The Life Cycle Effect?
    Much of Asian and Latin American business is built around family groups, which have roots that go back decades. Using a combination of connections and capital, these family groups have lived through economic and political changes, and as many of the companies that they own have entered public markets, they have stayed in control. In some cases, this control has come from dominant shareholdings, but more often, it is exercised by using holding company structures and corporate pyramids that effectively leave the family in control, even as the public acquires a larger stake in equity.
    To see how the corporate life cycle structure story plays out in family group companies, it is worth remembering that family groups often control companies that spread across many different business, effectively resembling conglomerates in their reach, but structured as individual companies. Consequently, it is not only possible, but likely, that a family group will control companies at different stages in the corporate life cycle, ranging from young, growth companies at one end of the spectrum to declining companies at the other end of the spectrum. In fact, one of the reasons family groups survived and thrived in economies where public markets were under developed was their capacity to use cash generated in their mature and declining businesses to cover capital needs in their growing businesses. This intra-group capital market becomes trickier to balance, as family group companies go public, since you need shareholder assent for these capital transfers. With weak corporate governance, more the rule than the exception at family group companies, it is entirely possible that shareholders in the more mature and cash-generating companies in a family group are being forced to invest in younger, growth companies in that same group. 

Implications for CEOs and Management
    There is research on CEO turnover in family group companies, and the results are not surprising. In a recent study, researchers looked at 4601 CEOs in companies, classifying them based on whether they were family CEO or outside CEOs, and found the forced turnover was much less frequent in the first group. In other words, family CEOs are less likely to be fired, and more likely to stay around until a successor is found, often within the family. While this is good news in terms of continuity, it is bad news if there is a company/CEO mismatch, since that mismatch will wreak havoc for far longer, before it is fixed. 
    What can family groups do about dealing with the mismatch, especially as the potential for that mismatch increases, as disruption turns some mature and growing businesses into declining ones and capital gets shifted to new businesses in the green energy and technology space? First, power has to become more diffuse within the family, away from a powerful family leader and more towards a family committee, to allow for the different perspectives needed to become successful in businesses at other stages in the life cycle. If, like me, you are a fan of Succession, the HBO series, you don't want to model yourself on Logan Roy, and the Roy family, if you are a family group company. Second, there has to be a serious reassessment of where different businesses, within the family group, are in the life cycle, with special attention to those that are transitioning from one phase to another. Third, if top management positions are restricted to family members, the challenge for the family will be finding people with the characteristics needed to run businesses across the life cycle spectrum. As many family groups enter the technology space, drawn by its potential growth, the limiting constraint might be finding a visionary, story teller from within the family, and if one does not exist, the question becomes whether the family will  be willing to bring someone from outside, and give that person enough freedom to run the young, growth business. Finally, if a mismatch arises between a family member CEO and the business he or she is responsible for running, there has to be a willingness to remove that family member from power, sure to raise family tensions and create fights.

Implications for Investors
   Are family group companies, in general, better or worse investments than investments in other publicly traded companies? The evidence, not surprisingly, is mixed, with some finding a positive payoff, which they attribute to a better alignment of long term investor and management interests at these companies, and others finding negative returns, largely as a result of management succession problems. 
    To address why family control can help in some cases, and hurt in others, it again helps to bring in the corporate life cycle.  In the portions of the corporate life cycle, where patience and a steady hand are required, the presence of a family member CEO may increase value, since he or she will be more inclined to think about long term consequences for value, rather than short term profit or pricing effects. On the other hand, if a family CEO is entrenched in a company that is transitioning from growth to mature, or from mature to declining, and is not adaptable enough to modify the way he or she manages the company, it is a negative for value. Family group companies composed primarily of companies in the former grouping will therefore trade at premiums, whereas family group companies that include a disproportionately large number of disrupted or new businesses will be handicapped. 

    I started this post by talking about Jack Dorsey leaving Twitter, and why the market celebrated that news, but I would like to end on a more general note. If there is a take away from bringing a life cycle perspective to assessing CEO quality, it is that one size cannot fit all, and that a CEO who succeeds at a company at one stage in the life cycle may not have the qualities needed to succeed at another. For boards of directors, in search of new CEOs, my suggestion is that you pay less attention to past track records of nominees, in their prior stints as employees or as CEOs of other companies) and more attention to the qualities that they possess, to see if they match what the company needs to succeed. 

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Tuesday, November 9, 2021

Tesla's Trillion Dollar Moment: A Valuation Revisit!

I have been writing about, and valuing, Tesla for most of its lifetime in public markets, and while it remains a company that draws strong reactions, it is also one that I truly enjoy valuing. It has been a while since my last valuation of the company, which occurred in January 2020, and given how much the landscape has changed since, partly as a result of the company's own actions and partly because of how COVID has upended its competitors in the automobile business, it is time to revisit the company and reassess its value, especially as the company’s market capitalization crosses a trillion dollars.

Tesla: The Back Story

I first valued Tesla in 2013, as a "luxury automobile company" and  I have valued almost every year since. If you are interested, you can see my valuations from 2014,  2016 and 2017. If you review those valuations, you will notice that in each valuation, my story for the company expanded, and my valuations increased, but the market price for the company jumped even more, leading me to conclude in each of them that it was not a company that I would invest in. While these valuations led me to different assessments of value, there were common themes across time:

  1. At its core, Tesla has been an automobile company: In my 2016 post on Tesla, I described it as the ultimate story stock, driven less by news about its most recent financial performance, and more by news that alters its story trajectory. I would be lying if I said that I have had clarity about Tesla's story over the last decade, because it has so many tangents, distractions and shifts along the way, flirting with narratives about being a battery company, an energy company and a technology company. In 2021, looking at the company, I feel more convinced than I was a few years that it is, at its core, an automobile company, and while it will continue to derive revenues from batteries and perhaps even software, its pathway to becoming a trillion dollar market cap company still runs through the "car company" story.
  2. Tesla has disrupted and reinvented the automobile business: Putting any company into the automobile business handicaps it, when it comes to value, for a simple reason. The automobile business has been in trouble for quite a while, struggling with anemic revenue growth in the aggregate, and abysmal profit margins, with even the very best in the group struggling to earn returns that match, let alone beat, their costs of capital. As I have valued Tesla over the years, I have come to the realization that it is the most 'uncar-like" automobile company in the world, and its uniqueness shows up on two dimensions. The first is on profitability, where its operating cost structure, unconventional distribution model (which bypasses dealerships), and capacity to augment revenues with related products and services, has given it an opening to deliver much higher margins than any automobile company in history. The second is on investment and capital intensity, where it has managed to take what critics pointed to as weaknesses (unwillingness to build large and expensive assembly plants ahead of time, to meet future demand) and made them into strengths. Put simply, the company has been able to scale up more quickly, while reinvesting less in capacity, than any other automobile company.
  3. Tesla positioned itself well for structural shifts in the economy: Tesla's success over the last few years has also been fed by three other external forces. The first is in the government and business response to climate change, and the resulting policies favoring electric cars over gas-powered, cars. It is undeniable that Tesla, especially in its early years, was a beneficiary of tax credits and other benefits meted out to electric car makers and buyers. The second is the rise of ride sharing, with a host of companies around the world upending the status quo in car service. While Tesla has not directly benefited yet from this trend, it has opened up possibilities for the future, built around self-driving cars, that have added to the company's allure. The third is the rise of ESG as an investing force, and the resulting shift away by investors from all things fossil-fuel related, has benefited Tesla, at the expense of the legacy automobile companies.
  4. Tesla is built around an outsized personality: When valuing publicly traded companies, I seldom talk about its top management explicitly, since the numbers reflect what they bring to the firm. That rule does not work with Tesla, since its founder and CEO, Elon Musk, has many qualities, but being self effacing is not one of them. Tesla and Musk are locked at the hip, and it is almost impossible to have a view on one, without having a similar view on the other. Put simply, I am still to meet an investor who loves (dislikes) Tesla as a company, and dislikes (loves) Musk. On the plus side, Musk is a visionary and out-of-the-box thinker, and an evangelist for his visions, who draws true believers to his cause. On the other side of the ledger, he is unpredictable and prone to distractions that draw attention away from the company, and his impulses have created costs for the company and its investors. While his net effect has clearly been a net positive for investors in Tesla, over the last decade, it is worth remembering that you are getting a package deal, when you invest in the company.
  5. Tesla draws extreme reactions: I have never valued a company, where there is as much divergence in views about the future, cross market players, that I have seen with Tesla and Musk. There are some who see Elon as the ultimate con man, and Tesla as a shell game, and many in this group have spent the last decade making Tesla one of the most shorted stocks in history. There are others who view him a savior, and map out pathways for Tesla to become the most successful company of all time, and many of them have bought shares in the company, and held through good and bad times. 

My two most recent valuations were in June 2019 and January 2020, and I am going to go back to them, not just because they are recent, but because they led to investment decisions on my part. 

  • In June 2019, Tesla had hit a rough spot, partly due to concerns about production bottlenecks and debt, and partly due to self inflicted wounds. Musk's tweets about going private, with funding secured, contributing to a sell off, driving the stock down to $180 ($36 in today's split adjusted terms). I valued the company, with conservative assumptions about growth and margins, and incorporating my concerns about managerial missteps, at about $190: While the buffer (between value and price) was small, I did buy shares in the company.
  • Between June 2019 and January 2020, the stock went on a tear, as the stock price more than tripled, and I revisited my Tesla valuation. With a more expansive view of future growth and profitability, I revalued Tesla in January 2020 and more than doubled my valuation, though that still left me well below the market price. I sold my shares then, and I know that many of you have pointed out how much money I have lost as a consequence of that sale, as the stock price has increased almost ten-fold since then, and I will come back and talk about my regrets, or absence thereof, towards the end of this post.

Tesla: The Numbers

    It has been roughly 22 months since my last valuation of Tesla, and it is astonishing how much change there has been, not just in the company, but also in the macro environment that it operates. In this section, I will start by chronicling the astonishing rise of Tesla in public markets in the last decade, follow by looking at the company's operating details and close by examining how the company has found a way to turn the COVID crisis into an opportunity.

Stock Prices and Market Cap

    To put Tesla's explosive performance in the last two years in perspective, I will look at its market performance since its entry into public markets. The graph below contains Tesla's stock price, adjusted for stock splits, going back to 2010, and ending in November 2021:

While the graph illustrates the surge in the stock price, the table embedded in the graph conveys the rise  more vividly, by listing Tesla's market capitalization in millions of dollars. In sum, the company's market cap has risen from $2.8 billion in August 2010 to more than a trillion dollars in November 2021, and along the way, it has not only made Elon Musk into the wealthiest man in the world, but also enriched those who bought into his vision early, and stayed invested in the company. 

Revenues and Earnings

    While the initial rise in Tesla's market capital was driven by the promise of the company, and detractors were quick to note Tesla's paltry revenues and big losses, the company's more recent financials reflect how it has acquired substance over time. In the graph below, I report on Tesla's quarterly revenues, gross profits and operating profits going back to 2013:

Tesla's quarterly revenues have risen from negligibly small values at the start of the last decade to almost $14 billion in the third quarter of 2021, making it the 20th largest automobile company in the world in 2020 (in revenue terms). The company spent much of the last decade losing large amounts each year, but it now not only generates an operating profit, but a healthy one at that, with a pre-tax operating margin of close to 15% in the third quarter of 2021.

The COVID Effect

    While Tesla's resurgence has been building for a while, its growth has clearly exploded in the last year and a half, a period where our personal and business lives have been upended by COVID. During this most trying of times for all businesses, and especially for those in manufacturing, Tesla has not just survived, but thrived, gaining market at the expense of its rivals and accelerating towards profitability. To understand why, I would point you to a series of posts that I did during 2020 about how COVID was playing out in markets, and the winners and losers. In particular, I noted to the following aspects that made the COVID crisis different, from prior crises:

  • Risk capital stayed in the game: The most striking feature of last year's crisis was how quickly markets came back from the savage sell off between February 14 and March 23 of 2020, and I argued that the biggest reason for that come back was the resilience of private risk capital. Instead of withdrawing from markets, as in prior crises, venture capital investing, initial public offerings and investment in the riskiest segments of both stock and bond markets continued, and actually increased, through 2020, and those trends have continued this year. 
  • Flexibility over Rigidity: While the overall market quickly recovered, the recovery was uneven, and the crisis left behind winners and losers. In this post, I argued that one of the key dividing lines between the two groups was flexibility, with companies with more flexible investing, financing and dividend policies winning out over companies with more rigidity on those dimensions. To be specific, service/technology companies gained at the expense of manufacturing & natural resource firms, debt-light firms won at the expense of those with much bigger debt burdens and firms that paid large dividends lost value, relative to firms that did not.
  • Young beat old: Another factor differentiating winners and losers during 2020 was that, unlike prior crises, young companies (early in their life cycles) benefited at the expense of mature and aging companies (with far more of their value coming from investments in place).
I summarized the transfer of wealth in a table in my final update:

As you can see young, high growth companies, with little debt and no dividends, benefited at the expense of older companies, with more debt and dividend commitments.  You could argue that if central casting were creating the perfect COVID winner, it would look a lot like Tesla, a young, adaptable company in a sector filled with companies with expensive manufacturing facilities, large debt burdens and legacy dividend policies. In fact, many of what many (including me) considered to be Tesla's weaknesses (make-shift manufacturing, seat-of-the-pants financing) in the pre-COVID age became strengths during COVID. While conventional automobile companies shuttered and scaled down manufacturing, Tesla continued to make and sell cars through the pandemic, and it is inarguable that it has come out of this crisis, far stronger than it was going into it. The table below breaks down the Tesla's performance from the last quarter of 2019 to the third quarter of 2021:

Tesla: The COVID Quarters
Focusing on the key financials of the company and looking at Tesla's performance through the COVID quarters, there are trends that stand out. 
  • The first is that the company stumbled briefly on revenues in the second quarter of 2020, as COVID restrictions kicked in, but saw a surge in growth in the quarters since, with growth rates significantly higher than in the pre-COVID years. 
  • The second, and more significant, is that the company seems to have turned the corner on profitability, with margins not just improving, but dramatically so, with gross margins moving towards 30% and operating margins exceeding 14% in the most recent quarter.
In brief, if there Tesla's growth was lagging, leading into 2020, and there were worries about its capacity to be profitable, the COVID quarters seem to have removed both concerns.

Tesla: Updated Story and Valuation

    I have long argued that the three most freeing words in investing and valuation are "I was wrong", and with Tesla, I have had to say those words repeatedly over the last decade. Through its lifetime, I have under estimated Tesla's value, and while COVID may have given the company an assist, my updated valuation will reflect what I have learned, since January 2020, about the company.

Story Components - Revisiting the Past

   Over the years, I have tried, not always successfully, to navigate between the extremes on Tesla, and tell a story that reflects the company's strengths and weaknesses. Not surprisingly, that story has changed over time, as the company, the business and the world have all changed. In the table below, I list the stories that I have told, with end-year revenues, operating margins and valuations for equity, for each one, in 2013, 2017, 2019 and 2020:

Over time, as you can see my story for Tesla has become bigger (in what I see both as its potential market and the revenues from it) and I have adapted my story to reflect the company's capacity to reinvest far more efficiently than the typical automobile company that I used in my very first valuation. 

    To see how much I was off the mark with my September 2013 valuation, I decided to compare my predicted revenues and operating income with the actual revenues and operating income from 2013-14 to 2020-21:

This may surprise you, since my 2013 valuation seems, at least in hindsight, to be hopelessly pessimistic, but I actually over estimated Tesla's revenues and profitability in the years since; the actual revenues in 2020-21 came in almost 24% below my prediction and my predicted margin of 8.52% was 0.75% higher than the actual margin posted by the company in that year. That said, I assumed in the 2013 valuation that, by 2021, Tesla's growth would be plateauing, and the company would be moving towards being a profitable, luxury car company. Instead, the company seems to be just getting started, redefining itself as a mass market company, with much bigger ambitions. I know that for some, my shifting stories and valuations are a sign of weakness, both in my analytical capabilities and in the very idea of intrinsic valuation. For me, and this may be just my delusions talking, an unwillingness to change your valuation stories and inputs, especially in a company that delivers as many twists and turns as Tesla, is a far greater sin.

Updated Story and Valuation
    Whatever your priors were on Tesla coming into COVID, it is difficult to argue with the fact that the company has benefited from the economic changes it has wrought, and that its story has become bigger. The question of how big is what will determine value, but rather than give you my assessment at the start, I want to try an experiment. Ultimately, whatever story you tell about Tesla has to show up in five inputs that drive its value: (a) Revenue growth, or what you see as end revenues for the company in steady state, (b) Business profitability, reflecting what you see as unit economics, and captured in the pre-tax operating margin, (c) Investment efficiency, measuring how much investment will be needed to get to your estimated end revenues, (d) Operating risk, incorporated into a cost of capital for the company and (e) the chance that the company will not make it, gauged with a probability of failure. If you are willing to go along, with each input, I will lay out the choices (as objectively as I can) and I would like you to take your pick, given what you believe about the company. As you make these choices, though, please do not open the spreadsheet that I will provide at the end, to convert your choices into value, since that will create a feedback loop that can feed your biases.
  1. Revenues: I do believe that Tesla has come out COVID with the potential for far more revenues than it did, going in. In particular, as the automobile market increasingly shifts to electric cars, Tesla will hold a strong competitive advantage in that portion of the market, and have the chance to be a market leader. To get a sense of what this will mean in terms of revenues by 2032, consider the following choices:

    Note that if your story draws primarily on Tesla remaining an auto company, revenues of $400 billion will translate into about ten million cars sold in that year, more than ten times the number of cars the company sold in 2020-21. If you believe that there are other businesses that Tesla will enter, you can augment your revenues with the added sales in those other businesses, keeping in mind that most of these businesses have far less revenue potential than the car business.
  2. Profitability: The biggest eye opener for me, during COVID, has been the surge in profitability at Tesla, with the operating margin nearing 15% in the third quarter of 2021. While that number is volatile and there will be ups and downs, it looks like the electric car business has far better unit economics than the conventional automobile business. Notwithstanding Tesla's first mover advantage, this margin will come under pressure not only from increased competition from electric car offerings from existing automakers and new entrants (Neo, Rivian etc.), but also from having to cut prices to increase market share in Asia, where car prices tend to be lower than in the US and Europe. Laying out the choices in terms of profitability:

    As you make this choice, recognize that Tesla is already approaching peak level gross margins for a manufacturing company, with its 30% gross margin in the last twelve months.
  3. Reinvestment:When I first valued Tesla in 2013, it had one plant in Fremont that produced all of the cars that it sold. At the time, one of my concerns was that the company would need massive reinvestment in assembly plants to ramp up even to luxury car revenue levels, and that this reinvestment would create significant cash burn. In the years since, Tesla has not only added capacity in lumps with assembly plants/giga factories in Storey County (Nevada), Buffalo (New York), Shanghai (China), Berlin (Germany) and Austin (Texas), but has spent far less than I originally estimated that they would have to invest. That said, if you are projecting that Tesla will sell 8, 10 or 12 million cars a year, a decade from now, it will need to reinvest in additional capacity. I use the sales to capital ratio as my proxy for investment efficiency (with higher values implying more efficiency investing), and the choices are below:
    To the extent that the company has the excess capacity to cover growth for the next few years, I will allow for a a higher sales to capital ratio in the early years, but move it towards a more sustainable number thereafter. 
  4. Risk: When I valued Tesla last in early 2020, I used a cost of capital of 7%, reflecting a risk free rate of 1.75% and an equity risk premium of 5.2% for mature markets. In November 2021, the risk free rate is down to 1.56% and equity risk premiums have drifted to 4.62%, and the cost of capital for the median firm had drifted down to about 5.90%. The choices you have on cost of capital are structured around those market realities:
    The other risk measure that will affect value is the likelihood of failure, a number that has varied over Tesla's history, partly because it used to lose money and partly because of a choice it made to borrow money in 2016. In making this assessment now, recognize that Tesla now has a cash balance that exceeds its debt due and is making money, at least for the moment.
  5. Management: Taking to heart how closely Tesla and Elon Musk are connected, one of the concerns with Tesla has always been the sheer unpredictability of Mr. Musk. The Musk effect on value can be positive, neutral or negative, depending on your priors:

    While Musk has been better behaved and more focused for the year and a half, with the exception of indulging in tweeting about cryptos, he seems to have reverted to bad habits in the last two weeks, seeking guidance from his Twitter followers on whether to sell a significant portion of his Tesla shares and indulging in a back-and-forth with senators about the billionaire tax.

I made the choices just as you did, and in the most upbeat of my forecasts, I aimed for revenues of roughly $400 billion (about ten million cars, augmented by revenues from ancillary businesses) in 2032, operating margins of 16% and a sales to capital ratio of 4.00 for the next five years (making Tesla far more profitable and investment efficient than any large manufacturing company in the world). With a cost of capital of 6% (close to the median company) and no chance of failure, it should come as no surprise that my estimated value of equity for the company has increased more than six-fold since my last valuation, to about $692 billion for equity in the aggregate, and $640 billion for equity in common stock.

Download spreadsheet

There are very few companies in the world that I would value at more than half a trillion dollars, and with Tesla, I get there almost entirely based upon its potential for growth and profitability. That said, though, the value per share that I get of $571, even in this most upbeat of scenarios, is less than half the current stock price, leaving me with the conclusion that the stock is over valued. Rather than take issue with my valuation, put your inputs into the attached spreadsheet and estimate your value of equity for the firm.

What’s your story?

    Given my choice to sell shares in Tesla at precisely the wrong time (in January 2020) and my history of undershooting on value for the company, I am the last person you should be relying on for your Tesla investment judgments. There are multiple caveats that go with my valuation, and it is possible that you are able to find a story that yields a valuation not just higher than mine, but also higher than the stock price. Alternatively, you might be one of those who believes that much of what we have seen as improvements in the last two years at Tesla are a mirage, and that I am being delusional in my assumptions. While I welcome debate and disagreement, I have found that, with Tesla, it is easy to get off on tangents and argue about what ultimately become distractions, and I would posit that almost any disagreement that we have about Tesla ultimately becomes one about how much revenues the company can generate from the businesses you see it operating in, and how profitable it will be as a company. 

  1. Revenues: In making my revenue estimates, I have assumed that Tesla will get a predominant portion of its revenues from selling cars, partly because of its history and partly because its alternative revenue sources (batteries, software etc.) are not big revenue items. It is possible, though, that there are new businesses with ample revenues that Tesla can enter, that can create new and substantial revenue streams. It is also possible that the electric car business will resemble technology businesses in their winner-take-all characteristics, and that Tesla will have a dominant market share of that business. In either case, you will have to find ways to get to revenues far greater than my already-daunting number of $414 billion in 2032. (Just for perspective, the total revenues of all publicly traded automobile companies, globally, in 2020-21 was $2.33 trillion and this would give Tesla roughly one sixth of the overall market.)
  2. Profitability: The other key driver of Tesla's value is its operating margin. While I think that my estimate of 16% is already at the upper end of what a manufacturing company can generate, there are a couple of ways in which Tesla might be able to get even higher margins. One is to enter a side business, perhaps software or ride sharing (with automated driving cars), that has much higher margins than the auto business. The other is to benefit from technological advantages to reap the benefits of economies of scale in production; this would require gross margins to continue to climb from less than 30% to much higher levels. 

You can check this for yourself, but the other assumptions about reinvestment and risk don't have as big an impact on value, and I have computed Tesla's equity value (in common stock) as a function of targeted revenues and operating margins.

As you can see, there are pathways that exist to get to the current stock price and above, but they require that you enter rarefied territory with Tesla, assuming that it will have more revenues than any company (not just automobile) in history, while delivering operating margins similar to those delivered by the largest and most successful technology stocks, none of which have the drag of substantial manufacturing costs. 

Tesla: The Pricing Game

     If you are holding or buying Tesla, finding a story to justify its current market capitalization will require a real stretch, a story that will require the company to not just be successful but a one-of-a-kind company. That said, I believe that Tesla is a "trade", not an "investment", and  that perspective provides answers to four questions that you may have about the stock.

  1. How do you explain the current stock price? For much of the last decade, Tesla skeptics have struggled with explaining why the stock is priced at the levels that it is, by the market. Put simply, they have wondered how a company with little revenue and big losses acquires a market capitalization of hundreds of billions of dollars. I have never tried to explain what other people pay for a stock, but the answer may lie in the fact that those trading Tesla are pricing it, based on pricing variables (mood, momentum), rather than on fundamentals (earnings and cash flows).  
  2. Why does the price change so much on news stories? Tesla has always been a company, where small and sometime trivial news stories cause big price changes. Take the news story a couple of weeks that Hertz was considering ordering 100,000 cars from Tesla. Given that the current market cap of Tesla reflects an expectation that the company will sell 10 million cars or more in a few years, the Hertz order, by itself, will have a tiny impact on value, and certainly far less than the hundred billion dollar jump in Tesla's market capitalization, after the news. However, if you view Tesla as a "story stock", the Hertz news story can be viewed as a sign that the company has made the transition from being a second car for the wealthy to a much wider market, potentially leading to a higher pricing.
  3. Does price affect value? Much as I would like to argue that intrinsic valuations are about cash flows, growth and risk, and are therefore insulated from market dynamics, the truth is more nuanced. The ten-fold surge in the stock price since last January did have an effect on my valuation, pushing me towards more upbeat and bigger stories, even though I still found the company to be over valued. If stock prices drop by 50% in the next few weeks, my assessment of value may be lower, as a consequence. In sum, it is almost impossible to value companies in a vacuum, where what the market is doing can be ignored.
  4. If I think the stock is over priced, why not sell short? To the question of why, if I believe in intrinsic value, I am not selling short on Tesla, it is because I believe that, at least in the short term, momentum beats fundamentals, and I have no desire to be caught in the whiplash effect. 
If you are a Tesla trader, I wish you the best, but I do hope that you don't delude yourself, if successful, with tales of fundamentals. You were on the right side of momentum, and whether this was a function of luck or skill, I will leave it for you to decide.


    In the last year and a half, I have heard from many of you about my decision to sell Tesla, and while I am thankful for your concern about my investment performance, there are a few of you who have asked me whether I was sorry that I had sold Tesla, just ahead of its  run-up in the last year and a half. I would be lying if I said that I did not think about the money I could have made, by holding on, when the stock crossed a trillion-dollar market cap, but those second thoughts have been fleeting and I have no regret. Like everyone else, I would rather make money on my investments, than lose money, but I would also rather leave money on the table and have an investment philosophy, flawed though it may be, than make money, and end up without a core set of beliefs about markets. I can say with certainty that I will be back valuing Tesla some time in the future, either because it has crossed a new threshold or because it is in the news. This company is far too interesting to ignore!

YouTube Video


  1. Automobile Sector in November 2021
  2. Tesla: November 2021 Valuation