Investors in iconic electric vehicle company Tesla

TSLA
should take heed: The stock is overvalued.

And its not just a little pricey. The odds are against the company’s financials being sufficient to justify the recent price.

Tesla: Great Company, Too Pricey

While Elon Musk’s company has managed to pull off the improbable — supercharging the longstanding dream of making electric vehicles available to the mass market — the math behind justifying the current stock price makes little sense.

As a recap, the stock is up 410% in the year through Friday, versus a gain of 16% for the S&P 500, according to data from Yahoo. Neither figure includes dividends. That stellar performance alone doesn’t make the stock overvalued.

What does are at least two things.

Stratospheric P/E

The first is Tesla’s forward looking price-earnings ratio, which is now at 200, according to Morningstar. Put simply, the price of the stock is currently trading at 200 times next year’s profits.

To put that in context, some investors worry that the S&P 500 is overvalued because its forward P/E is around 25, far above historic norms. If the market as a whole is overvalued then surely a stock trading at almost 10 times higher (on a P/E basis) is overvalued?

Maybe, maybe not. The high P/E alone isn’t enough to damn the stock as overvalued.

If the growth of the profits is fast enough then theoretically the stock could be fairly valued even with a mega-high P/E. However, the higher the P/E is above what is normal the more difficult it is to justify.

In essence, it comes down to a simple question: Is it probable for the profits of Tesla to grow enough to justify its current price? If it isn’t, then the stock is too pricey.

Bring On The Actuaries

Friday I spoke with Julian Koski, chief investment officer at New Age Alpha, Westchester NY. He explained that his company looked at the most recent 16 quarters of Tesla’s financial statements and then tried to figure out whether the company would likely make enough money to justify its lofty price.

Koski and his team use actuarial methods to calculate the odds that a company will make the profits that investors are expecting. For those who don’t know, actuaries are super mathematicians who try to work out the probabilities of events happening in the future.

Odds Against Tesla Making Enough Money To Satisfy Investors

In this case, the answer was that Tesla was 55% likely to fail to meet the required profit level, Koski says. Or put another way, more likely than not the company will fail to make as much money as investors are expecting.

Anyone who has played cards knows that it is prudent to fold your hand when the odds are against you. And for investors in Tesla, the time to fold may have come.



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