Despite its soaring valuation. Sure, the stock is getting expensive, but the company is executing at an accelerated pace, cash flow is improving, and the future looks bright .
Reasons To Still Hold The Shares
Tesla has certainly been giving shareholders good reasons to hold onto the stock. During the first quarter of 2020, Tesla launched its Model Y SUV about six months ahead of management's initial timeline. Throughout the year, Tesla rapidly expanded production and made progress on the construction of new factories. And more recently, Tesla has been reporting sharp growth in vehicle deliveries and significant cash flow improvement. Third-quarter free cash flow, for instance, was $1.4 billion. Even when excluding sales of regulatory credits, third-quarter free cash flow was about $1 billion. Further, vehicle deliveries in the second half of the year were up 53% year over year.
Equally exciting is Tesla's potential in 2021. Given the company's aggressive buildout of new factories and production lines throughout 2020, it wouldn't be surprising to see 2021 vehicle deliveries increase 50% or more over 2020 levels.
Selling shares of a business doing this well could be a mistake. After all, Tesla's recent execution essentially exceeded most investors' expectations in 2020. Who's to say the company won't do the same thing in 2021?
Reasons To Trim The Shares
But here's the issue. No matter how exciting Tesla's business is, valuation matters -- and the electric-car maker's valuation is simply difficult to justify.
Tesla currently has a market capitalization of more than $800 billion. Yet trailing-12-month free cash flow comes in at just $1.8 billion. Even on a price-to-sales basis, the stock looks expensive. Tesla trades at about 29 times its trailing-12-month sales and 18 times analysts' average forecast for 2021 sales.
Of course, there's still potential for Tesla to live up to this valuation. But it will likely require execution in speculative areas like self-driving technology and the company's nascent energy-storage business. In addition, there needs to be a tipping point in which electric vehicle sales start rivaling gas car sales.
What Should You Do Now?
For investors with a high-risk tolerance and who are willing to hold onto these shares for five to ten years or more, buying the stock at this valuation will be a good idea. But Short term traders should consider trimming their position in Tesla , particularly if it has become outsized in relation to other portfolio holdings and buy back later when the pull back is over.