Why Tesla Is the Most Dangerous Stock on the Market Today

Tesla may be the most dangerous stock of the last 20 years for new investors.

That sounds provocative, but I will explain exactly why everyone looking for the “next Tesla” is doomed for failure.

If you made money on Tesla stock, amazing!

But Tesla’s stock market success isn’t something competitors will be able to copy and doesn’t portend anything about the EV market overall. Most of Tesla’s competitors will go bankrupt, following Lordstown Motors, Proterra, and Fisker to the financial graveyard.

From where I sit, too many investors are learning the wrong lessons from Tesla’s success in the stock market. And I cringe every time I hear the words “next Tesla”.

Today, I want to dig into the EV industry’s financial reality and challenging economics and show why stocks like Rivian, Lucid, and even Tesla are NOT in the Asymmetric Portfolio.

Operating Leverage Rules Everything

At a very simple level, we can break every company down a company’s operating profit (or loss) into its components. The equation looks like this:

Operating Profit = Revenue - Variable Costs - Fixed Fixed Costs = Sales - COGS - Operating Expenses

It’s a simple equation, but its impact on investing is profound.

Here are a few more definitions that will help as we work through the concept of operating leverage.

• Gross Margin = Sales - Cost of Goods Sold

  • This can be expressed as a dollar figure or a %

• Operating Expenses = R&D and Sales, General & Administrative expenses

  • This is all of the overhead costs to operate the business like paying executives, accountants, the marketing team, R&D efforts, etc.

Depending on factors like gross margin rate and the level of operating expenses, companies can have very different leverage on their sales.

To dig into how leverage works, let’s start with the variable and fixed cost components and I’m going to use Rivian as an example. Rivian has about $4 billion in annual operating expenses (SG&A and R&D) that are relatively fixed. In time, management thinks they can get to a gross margin rate of 25%. Based on these numbers, the company’s fixed and variable costs look like this with revenue on the X-Axis:

In other words, to sell $2 billion of product, Rivian would have to incur $4 billion in operating costs and $1.5 billion in variable costs (raw materials, labor, etc).

Add the fixed and variable costs and you get Rivian’s total expenses in black below.

Here’s where we get to the leverage part. If you subtract total costs (black line) from revenue (X-Axis) you get the operating profit (yellow line) line that shows how quickly profits grow with revenue.

If we isolate the operating profit, we get the chart below. This is your operating leverage. The steeper the slope of the curve, the better you leverage each dollar of incremental revenue.

I’ve added two more gross margin scenarios of 20% and 15% because they’re more realistic for an automaker. You can see the profit line flattens out as gross margins go down. Even at $20 billion in revenue (4x the company’s revenue today) Rivian goes from $1 billion in operating profit at a 25% gross margin to a $1 billion loss at a 15% gross margin. This is why investors watch auto margins like a hawk.

Operating costs are like a hurdle for companies to overcome, and the lower gross margins are the harder it is to overcome the hurdle.

This is why investors like tech stocks so much. The gross margin for tech is generally 70%+, so any growth flows disproportionately to the bottom line. And tech revenue isn’t constrained by manufacturing capacity.

You can see that below at Meta, where operating costs were held flat over the past two years while revenue is up at a 21.5% CAGR and operating income wildly outpaced that with a 65.4% CAGR. And without capacity constraints, the upside of winning in tech is orders of magnitude larger than in manufacturing.

Supply and Demand In Manufacturing

These operating leverage charts are important in EVs because the industry has high fixed costs. That’s the inherent nature of manufacturing.

And gross margin is dependent on pricing. And pricing — SURPRISE, SURPRISE — follows the laws of supply and demand.

Depending on price, customers will demand a certain amount of product. Raise the price, and demand falls. I’ve shown this supply and demand curve below.

• Supply Curve: Shows the quantity of goods producers are willing to sell at different prices.

  • In short, if the price of a product goes up, they’re happy to make more.

• Demand Curve: This shows the quantity consumers are willing to buy at different prices.

  • In short, if the price of a product goes down, they’re happy to buy more.

The simple supply and demand curve looks like this. A company with inelastic demand will have a very flat demand curve (ex. oil) and a company with a highly elastic demand curve will be more vertical (luxury goods).

If we stay with Rivian for this example, the company is in an equilibrium of supply and demand at $50,000 per vehicle and producing 50,000 vehicles per year.

They have excess demand if they produce 40,000 vehicles and charge $50,000 for each vehicle.

But if Rivian increases production to 100,000 units and maintains a $50,000 price point, they have an excess supply of 50,000 units because there are only 50,000 units of demand at that price point.

The options Rivian has in an oversupplied environment are both terrible for the company’s economics:

1. Cut production, causing the company to run less efficiently and eat the cost of excess capacity.

2. Lower prices, reducing gross margin per vehicle.

This is the reality of the EV business today. Supply is growing faster than demand. Companies aren’t cutting back their expansion plans — because they can’t maintain the money-losing status quo — and the supply/demand imbalance will get worse.

You can see evidence of this dynamic in Tesla’s numbers. You can see below that Tesla likely had excess demand through the end of 2022 (helped by pandemic demand) when it produced 1.3 million vehicles. But in 2023, the company increased capacity to about 2 million vehicles and needed to lower prices to sell products. Tesla was in a state of oversupply and margins and operating income fell as a result.

Tesla is the one EV company that’s reached scale, but others want to follow. What happens to the market when Rivian, Lucid, Polestar, Xpeng, BYD, GM, Ford, and others ALL increase EV production?

Supply goes up and unless demand follows at the same rate…

PRICES ARE GOING TO FALL!!!

Margins are going to get worse.

The operating profit curve is going to flatten. And who can make money in that scenario? Maybe Tesla???

The logical conclusion is that most EV companies will go bankrupt.

Why Tesla Is a Dangerous Stock

Why do I say Tesla is a dangerous stock for investors? Because its economic success thus far doesn’t indicate that others will have the same economic success and doesn’t even indicate that Tesla itself will make money in the future.

Logically, its valuation makes no sense in the context of other automakers. It’s gone so far as to say it’s not really an automaker, it’s an AI and robotics company. Why? Because the economics of the EV industry kind of stink. And Tesla is never going to live up to a $657 billion valuation selling cars into an oversupplied market.

Maybe Tesla can become an AI and robotics company, but Rivian can’t. Lucid can’t. Nikla can’t. This puts EV companies between a rock and a hard place because they have no alternative but to try to increase capacity to reach positive operating profit eventually, even if they risk bankruptcy in the process.

Does Rivian make a great truck? Yes.

Can Rivian generate a high enough gross margin at a high enough volume the overcome its current operating expenses and reach profitability?

I doubt it.

And Rivian is arguably in the best shape of these EV manufacturers.

Polestar, Lucid, Canoo, Nikola, and everyone else who’s trying to scale up in EVs won’t become the next Tesla and likely won’t survive.

That’s the reality of the EV business and it’s because of operating leverage (or lack thereof) and the laws of supply and demand.

Why Tesla Succeeded (& Why Tesla Can’t Be Copied)

Tesla succeeded because it had a founder who could attract endless amounts of money by making his vision bigger and bigger. Remember when the Gigafactory was announced alongside a stock sale and the stock went up?!?!

Tesla was also a first mover in a market where revenue numbers get really big really fast.

And let’s not forget about that little pandemic that started in 2020 that left the entire auto industry undersupplied. Tesla raised prices during the pandemic because it had excess demand. But you can see in the last year that price increases didn’t stick.

There’s nothing “normal” or “repeatable” about Tesla. It’s an anomaly for a million reasons.

And I wouldn’t say that because Tesla did it Rivian or Lucid or Plug Power or ATS SpaceMobile or any other company can do it. There is no “next Tesla”.

If you learn anything from Tesla, learn about why the company’s margins and cash flow dropped over the past two years as it sold more EVs than anyone else. That lesson will be more useful in analyzing other stocks than anything the stock could have taught in the prior decade.

Disclaimer: Asymmetric Investing provides analysis and research but DOES NOT provide individual financial advice. Travis Hoium may have a position in some of the stocks mentioned. All content is for informational purposes only. Asymmetric Investing is not a registered investment, legal, or tax advisor or a broker/dealer. Trading any asset involves risk and could result in significant capital losses. Please, do your own research before acquiring stocks.