The Obscure Premium That Justifies Tesla’s Insane Valuations

Tesla Inc CEO Elon Musk attends an opening ceremony for Tesla China-made Model Y program in Shanghai, China, on Jan. 7, 2020. Aly Song/Reuters

Commentary

I’ve recently been trying to get my head around Tesla’s ridiculous valuations.

I have to confess, it’s been a struggle.

Even after the current pullback in the market—with Tesla down 25 percent from its high back in November 2021—and despite its recent spate of recalls, it’s still outrageously valued.

Its current P/E ratio is still over 300. That means investors are willing to pay $300 for every $1 the company earns. There’s a certain level of over-optimism there.

I had been thinking about it for a while when suddenly the light went on. … It’s something I’ve seen before. So I gave it a name.

I call it the Genius Premium.

The High Price of Genius

There are two things to understand about founder-led companies: first, venture capital funds love them and second, it’s rare for a founder to lead his or her company for any length of time. Most simply don’t have the ability to be objective about their businesses.

Nevertheless, founders are the visionaries—the geniuses, if you will—behind their companies. They become inseparable from the businesses they build. Think about it.

Someone says Tesla and you think Musk.

They say Amazon and you say Bezos.

They say Microsoft and people think Gates (who’s not even the CEO anymore).

They say Apple and it’s still Steve Jobs (who’s dead for crying out loud!).

How many companies’ CEOs have that kind of recognition? Ford and GM are two of the best-performing companies out there, but I’d bet less than half a percent of investors could name their CEOs.

The genius premium is a bit of a wild card. But when a founder draws it, their association with their company becomes so strong that their personality, their vision, their genius becomes an asset on the firm’s balance sheet.

Which can become a liability when it’s time to hand over the reins.

Impossible Handoffs

The fact that Steve Jobs was able to hand the reins of his company over to Tim Cook without the company skipping a beat had to be a sheer stroke of luck. Rarely do things go smoothly when founders step down.

Take Bill Gates and Microsoft.

In 2000 Gates stepped down as CEO and handed the day-to-day operations to Steve Ballmer while keeping the reins of the “technological vision” aspect of the company. In 2006, he handed those over as well.

Although the company did well enough financially under Ballmer’s leadership (the stock’s price did stagnate) considering what he was given when Gates left, it’s stunning that he couldn’t accomplish more.

Through nearly his entire tenure, Windows and Office still accounted for the majority of the company’s profits. In 2013 he was named one of the top five worst CEOs by the BBC.

But I digress.

In thinking about Tesla’s current valuation, it brought to mind another valuation conundrum from back in the 1990s.

If you think it’s hard to get your head around the valuations the market has put on Tesla, consider Amazon.

Insane ‘Founders Valuations’

In 1999, just prior to the tech crash, Amazon printed an all-time high price of $113 on no earnings. It was all downhill from there once the bubble blew, with the stock bottoming out in late 2001 at $5.50. The long grind back higher began from there. It wasn’t until 2009 that Amazon reached its pre-crash high.

Yet despite all those years in the metaphorical wasteland, when Amazon finally got around to posting their first earnings in 2004, their P/E ratio was an astounding 649. That puts Tesla to shame!

But in hindsight, we see that Amazon was actually a cash cow. But Bezos’ vision wasn’t just to sell books online. Rather, it was to dominate the online retail market. So he and Amazon reinvested every penny it could—even earnings—to become the online juggernaut that it is.

Tesla Isn’t a Car Company

One criticism of Musk is that after over 10 years, Tesla’s production isn’t even close to the other major automakers. ARK Invest’s Cathie Wood will tell you that’s because Tesla’s product line is 100 percent EVs while the same output at other manufacturers is considerably lower.

But even that’s looking at the situation all wrong.

Founder companies and their genius premiums often aren’t in the business you think they are. Said another way, you can’t compare Tesla to other car companies because they’re not a car company.

No, Tesla is an AI company. They’re a software company. A battery technology company. I could be completely wrong, but someday, when autonomous-driving technology finally comes to the market, it’ll likely be Tesla’s technology that all other car manufacturers are using.

This is the only way to justify the current valuations of the company.

And right now there is a big premium on Elon Musk. Personally, I think he’s a one-in-a-million visionary. But buying Tesla stock is probably not the right way for most individual investors to capitalize on this genius premium.

I’d suggest looking to the “picks and shovels” companies—AI software makers or battery innovators—that will help build his vision.