Elon Musk, currently tied with Jeff Bezos as the world’s wealthiest person, recently tweeted, “I thought 1999 was peak insanity but 2021 is 1000% more insane!” In case anyone was confused about what Musk was talking about, the Dealbook section of The New York Times helpfully explained that he was sharing his “amazement” about “how much investors have bid up stock prices.”
He could have been, or should have been, referring to his own company. Tesla’s market value is now around $730 billion, nearly six times the combined sum of both GM and Ford. Since Tesla went public in 2010, its stock is up nearly 20,000 percent, the vast majority of the growth having occurred in the past two years. There’s no question that Tesla is cooking with gas. In the first six months of 2021, Tesla sold 203,736 more cars than during the first six months of 2020, generating $8.8 billion in revenue.
It’s worth noting, though, that 10 percent of Tesla’s revenue from the sale of its electric cars, or $872 million, comes from the sale of “regulatory credits,” which Tesla sells to other car companies so that they can comply with regulatory emission standards. Those regulatory credits are basically pure profit for Tesla and accounted for nearly half of its pre-tax profit, of $1.8 billion, in the first six months of 2021. In the last twelve months, ending June 2021, Tesla earned $2.166 billion, of which $1.67 billion, or 77 percent, came from selling carbon credits to other car manufacturers. Stepping back for a minute, Tesla’s market value of $730 billion is 337 times its last twelve months’ net income, of which only a small percentage actually comes from selling its electric cars. Talk about insane!
Such a mind-boggling valuation raises a larger question on Wall Street, which has become forward-looking to the point of myopia. Tesla’s 337x multiple represents widespread investor enthusiasm about the company’s potential commercial prospects. Similarly, Amazon, which has a market capitalization of $1.75 trillion, is valued at around 80x its 2020 net income of $21.3 billion. But what about veritable blue-chip cash machines that are currently operating brilliantly? If JPMorganChase, which makes net income of around $40 billion a year, were valued like Tesla, the equity of the nation’s largest bank would be worth nearly $13.5 trillion, or more than 5x the nation’s most valuable company, Apple, at $2.5 trillion. But JPMorganChase, which has done nothing but continue to grow and become more powerful under the careful tutelage of Jamie Dimon, is not valued at Tesla’s multiple. It is valued at a far more modest $478 billion, or 12x its net income of $40 billion.
Why do investors get all excited about Tesla’s potential, but seem so blasé about JPMorganChase’s? I’ve never understood it, frankly. It seems investors would rather overpay for the prospect of some amorphous future profits coming out of Tesla rather than the seemingly assured $40 billion of profits coming out of JPMorganChase, year after year. When I spoke with Dimon in June, he told me that most of the bank’s $120 billion of annual revenue is recurring, with only trading and a few other parts of investment banking being subject to market volatility. That’s quite a moat that Jamie has built.
Back in the days when I was still an investment banker, we used to try to explain this weird discrepancy among investors by focusing on the different growth rates of a company’s earnings, a so-called PEG—price-to-earnings growth—ratio. As was the case then, and even more so now, investors are willing to pay up for companies with higher earnings growth rates, rather than for companies that actually produce high earnings today.
I never quite understood this quirk of market psychology. According to Zacks Research, a PEG ratio below 1 means that a stock is trading below its expected earnings growth rate, and thus is undervalued on a relative basis. A PEG ratio greater than 1, on the other hand, means that a stock is valued higher than its expected growth rate. (This I get.) According to Zacks, Tesla’s PEG ratio is 5.29. In other words its stock price is valued at 5.29 times the expected rate of its earnings growth, or wildly overvalued compared to its earnings growth prospects, even though Tesla’s earnings are expected to grow quickly. By contrast, Apple’s PEG, according to the Nasdaq, is 2.2. JPMorganChase’s PEG is 2.1. Investors are paying much less for Apple’s future growth and JPMorganChase’s future growth than they are for Tesla’s.
Compare those numbers to FedEx, which has a PEG ratio of 1.23 and an increasingly profitable business. Its P/E ratio is 14.4x and it is expected to grow its earnings 12 percent a year for the next few years. So, Tesla shares look hyper expensive while FedEx’s shares look relatively cheap. Yet investors can’t seem to get enough of Tesla’s shares, which are up 48 percent in the last year, while FedEx shares are up 21 percent in the last year. Leave it to a behavioral economist to explain why.
Of course, the financial markets have always been a confidence game. When stocks and bonds are priced for perfection (as they are now), or when “irrational exuberance” has kicked in, as former Fed chairman Alan Greenspan declared back in 1996 (when stocks were not nearly as exuberant as they are now), most Wall Street analysts, and many investors, only see the good times continuing. The S&P 500 just notched its seventh monthly increase in a row in August, and now stands at around 4,531. Mark Haefele, the chief investment officer at UBS global wealth management, predicts the S&P 500 will hit 5,000 by the end of 2022, or another 10 percent increase from here. He wrote in a recent note to investors that his continued optimism is based upon higher corporate earnings growth, a full economic recovery from the pandemic, and the continued support of the Federal Reserve, which seems determined to keep the party going at all costs. Evercore’s Ed Hyman, the top economist on Wall Street, concurs with Haefele. “The S&P trading above 4500 further clinches the case that the US economy is powering ahead,” Hyman wrote to his clients.
One can’t help but admire the collective optimism that investors continue to display in the American experiment, despite our pathetic response to the pandemic, our love of engaging in unwinnable wars, and our increasingly uncivil society. Indeed history has shown that absent world wars, financial crises, and meteor strikes, the stock market does seem to climb inexorably year after year. And it’s possible that some of the predictions will come to pass: perhaps Amazon will continue to take over the world—it’s entering markets such as healthcare, banking, and the military—and its market value will zoom past $2 trillion and beyond. The same could be true for Apple and Google, who are sitting on billions to reinvest in their growth machines. Maybe the trees will continue to grow to the sky. Maybe this time will be different.
But I doubt it. Mike Wilson, the chief U.S. equity strategist at Morgan Stanley, wrote recently that he expects a “comeuppance” in the financial markets that could result in a correction of 10 percent, or more. When the Fed starts pulling the plug on its 12-year Quantitative Easing experiment, when the cost of money starts rising and reaches its true equilibrium where investors are getting paid appropriately for the risks they are taking, then we will start seeing one high-flying stock after another return to Earth. When that happens—and it could be soon, given the Fed’s recent insinuations about the denouement of the Q.E. decade—many investors may prefer to own JPMorganChase’s stock, valued at 12x its expected earnings, rather than Tesla’s at 337x its expected earnings. Or better yet, FedEx’s stock, with a PEG ratio of 1.23.
Why have so many investors lost their minds? Maybe it’s because owning certain stocks has become another mark of our bizarre tribalism, a way to support and to identify with certain C.E.O.s, products, ideas, communities. Others are simply along for the ride, or know not to fight the Fed, or are hoping for a bigger fool to come along and rescue their portfolio. But speculation is a surefire way to lose money when the pumping stops and the dumping begins. And what seems like supreme confidence one day can fade quickly the next. Maybe when Tesla starts making more money from selling cars rather than from selling carbon credits, its stock will be worth a look—though perhaps not at the fanciful $3,000 per share that Cathie Wood, the current equity Svengali, has predicted (she’s just talking her book). Until then, Musk is absolutely right, 2021 is 1,000 percent more insane than 1999, and no one has benefited more than he.