Tesla (TSLA 0.23%) is one of the most polarizing companies on Wall Street. The stock rocketed more than 1,000% from Jan. 1, 2020, through Dec. 31, 2021, briefly joining the $1 trillion market capitalization club late last year. Since then, the tables have turned -- the electric vehicle (EV) giant has contracted 41% year to date as of this writing, and its market value now stands at $729 billion.
The bulls insist that the recent pullback presents a golden buying opportunity, and that the Elon Musk-led enterprise is poised to return to the $1 trillion zone in the near future. There's no doubt that Tesla has continued to forge ahead on the operations front. Its total revenue surged 81% year over year in the first quarter to $18.8 billion, and its adjusted earnings per share rallied 246% to $3.22. Beyond its rock-solid growth rates, the company's business is swiftly becoming more profitable, with its gross margin finishing at 29.1% versus 21.3% in the same quarter a year ago.
That said, not everything about the EV leader is perfect. Even those who believe in the long-term trajectory of the business should not blindly invest in the company today. Here are three downsides to consider before buying Tesla stock.
Image source: Getty Images.
1. Unfavorable macro conditions
Our current economic environment certainly isn't ideal for consumer discretionary companies. Inflation has soared to 40-year highs, and the Federal Reserve has responded by adopting a more hawkish view on monetary policy to curb rising prices. It seems as if the Fed will not hesitate raising interest rates until the ongoing inflation problem is resolved. This has led to higher input costs for Tesla, which in turn prompted the EV leader to hike its car prices across the board. This makes the company's vehicles less affordable, especially in a high-inflation environment.
Musk doesn't appear to be too confident in the economy overall. The controversial entrepreneur reportedly emailed executives in early June, asking the company's human resources department to "pause all hiring worldwide," and he also reportedly wants to lay off 10% of the company's salaried employees. Up to this point, demand for Tesla vehicles remains intact, but a deeper economic downturn would likely lead to a drop, and laying off employees would offset any adverse effects from weaker sales.
Fear of a recession continues to spook investors, which could mean more not-company-specific downward pressure on Tesla stock. Combined with the dread of more COVID-related factory shutdowns, supply chain restraints, Musk's Twitter takeover drama, and global impacts from the war in Ukraine, which has intensified volatility in the stock market, the EV leader could face a variety of challenges for the foreseeable future.
2. A crowded industry
With some research predicting the global EV market will expand at a compound annual growth rate (CAGR) of 19.8% through 2030, up to $1.3 trillion, everybody wants a piece of the EV pie. Right now, Tesla is the clear pacesetter in the arena, boasting a 14% share of the global EV industry.
Competition is heating up, however. Pure-play EV companies like Lucid Group and Rivian Automotive are rapidly entering the market, and traditional auto manufacturers like General Motors and Ford continue ramping up investments in the EV space. Although the industry is big enough to support several winners, competition will only accelerate moving forward, which will exert pressure on Tesla's global market share.
Growing competition could disrupt Tesla's growth story and reduce its margins over time. The bulls point to other high-potential business segments like full self-driving cars and energy storage, but the truth is that the company generates the majority of its revenue via automotive sales at the moment. While I definitely believe in the future of Tesla's business, it would be ignorant to ignore the big elephant in the room today: intense competition.
3. Valuation
It's hard to look past Tesla's remarkably high valuation, even in spite of its latest pullback. The stock is trading at 57.2 times forward earnings at the moment. To put that into perspective, traditional auto manufactures Ford and General Motors have forward price-to-earnings multiples of 7.0 and 5.4, respectively.
TSLA PE Ratio (Forward) data by YCharts
One could argue that the EV juggernaut deserves a premium valuation, given its hot growth rates, elite market positioning, and unparalleled future commercial prospects. Then again, the company is facing more competition than ever before, and many of its promising business segments, like full self-driving cars and energy storage, have not demonstrated a whole lot of development up to this point.
Investors who buy the stock need to know that they are paying a very steep price. Although buying the EV stock at existing price levels could lead to massive gains down the road, the company's rich valuation doesn't necessarily offer investors a strong margin of safety. The company ended last year trading above 300 times earnings, so Tesla's earnings multiple has shrunk a lot, but the stock is still expensive compared to traditional auto manufacturers.
