Shares of electric-car company Tesla (NASDAQ:TSLA) have been on a tear recently. Over the past year, the stock is up more than 750%. In the last five trading days alone, shares have risen almost 40%.
The growth stock‘s huge move higher over the last year was initially driven by better-than-expected business execution. Lately, however, news of an upcoming stock split seems to be the primary driver for sharp gains.
Has the stock’s run-up gone too far? Or is the stock actually attractive at this level?
Investors love Tesla’s growth story
It’s not surprising that investors have applauded Tesla’s recent business performance by buying up shares over the past year. The company went from regularly missing delivery targets and production milestones to overdelivering on many of its plans. Last year, for instance, Tesla went from breaking ground to initiating vehicle production in under a year at a new factory in Shanghai. This year, the automaker started delivering its Model Y about six months ahead of schedule.
More recently, Tesla said the Model Y impressively achieved a positive gross profit margin in its first quarter of production. Meanwhile, the company’s Model 3 has become the best-selling vehicle in China, which is the world’s largest auto market. And construction at yet another vehicle factory in Berlin is progressing rapidly.
Solidifying the company’s growth story, Tesla reiterated pre-COVID guidance for a half-million deliveries in 2020, despite enduring factory shutdowns in both the U.S. and China earlier this year. If the automaker achieves this (and there’s a high chance it will), deliveries in 2020 will be up 36% year over year.
Finally, investors are likely excited about the massive addressable market in front of Tesla. Total global electric vehicle sales in 2019 were about 2 million, accounting for just 2.6% of auto sales worldwide during the year, according to International Energy Agency estimates.
Despite Tesla’s strong momentum in vehicle sales and its huge growth opportunity, there’s one major factor that makes the automaker’s shares less attractive today than they might seem on the surface. After a 750%-plus run-up, the stock’s valuation has become stretched, even when viewed next to a rosy outlook for the company.
With shares trading around $1,888, the stock’s market capitalization is $352 billion. Yet Tesla’s trailing-12-month free cash flow is just $800 million. With a premium like this, investors have essentially priced in 20% to 35% average compound year-over-year revenue growth and substantial improvements in profitability for a decade or even longer. In other words, Tesla stock may now be priced for perfection.
Sure, it’s always possible that the underlying business goes on to exceed even these high expectations, making today’s stock price look good in hindsight. But investors should keep in mind the stock’s torrid run higher recently has made shares significantly less attractive than they were even just a few months ago.
While an upcoming five-for-one stock split may have brought more interest to the company for now, investors should always keep valuation in mind when making investments. There’s no telling when the market may decide to price Tesla stock more reasonably. And if that day does come, there’s a chance that investors in the automaker will never opt to pay such a significant premium for Tesla’s free cash flow again, ultimately inhibiting long-term return on investment from these levels.
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