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Tesla: Massively overvalued, or an Amazon-style growth story?

Chris Umiastowski is the growth investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

I wrote about electric car maker Tesla Motors Inc. back in May, shortly after buying the stock for my personal portfolio. I was interested in adding Tesla to my Strategy Lab portfolio as well, but the stock had already jumped from my mid-$50 (U.S.) purchase price to nearly $70. Given the rapidity of the rise, I said I would love to see the stock drop significantly, making it cheaper to buy.

No such luck. Tesla shares are now above $150 each, and the market capitalization has soared to about $18-billion. My own position has nearly tripled in value.

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What's going on here? Another Amazon-style growth story? Or simply a stock that has become massively overvalued because of investors' gullibility?

I tend toward the former viewpoint – with caveats. And I base my enthusiasm on an appreciation of just how far Tesla has already come.

Its flagship car, the Model S electric sedan, is a luxury vehicle that sells for close to $100,000. Yet with almost no retail presence and next to no advertising, the Model S has stolen the No. 1 spot for luxury sedan sales in the U.S. market since being introduced in June of last year.

Financially speaking, the company's progress has been incredible. Revenue for 2012 was only $413-million, but is on track to soar five-fold this year, according to analysts surveyed by S&P Capital IQ. Telsa is also steadily driving towards its goal of achieving a 25 per cent gross margin on the Model S by the fourth quarter of this calendar year.

To be sure, Tesla is no bargain at current prices. It is making about 6,000 cars per quarter now. Let's assume it reaches the 25 per cent gross margin target by fourth quarter. This should drive earnings per share to about $3. With a $150-plus stock price, that gives us a P/E ratio of 50, which is hardly cheap. But as with all growth stories, what matters is what Tesla is driving towards.

There are two major growth catalysts for Tesla over the next three years. The first is the rollout of the Model S outside of North America. Deliveries to Europe just started this month, while deliveries to China, Japan, and other countries will take longer.

It's quite possible that demand in Europe will match U.S. levels, while Chinese demand could exceed it. CEO Elon Musk is confident Tesla will be shipping 40,000 sedans per year by the end of next year. In two years I wouldn't be shocked if sales were above 60,000 annually.

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Tesla's luxury SUV, the Model X, is the second major catalyst for the stock. It is scheduled to ship late next year, and Mr. Musk says it will do 0 to 60 mph faster than a Porsche 911.

In the United States, SUVs account for about one in three vehicles sold and I see no reason why the Model X won't fill a similarly sized part of the market for Tesla vehicles. If so, Tesla could be shipping 90,000 luxury cars per year within three years and generating $6 to $8 a share in profit.

This scenario, if it comes to pass, would justify an $18-billion market capitalization down the road. It doesn't, though, explain why the stock is trading that high already.

The big force driving the stock upward seems to be the high hopes around what Tesla calls its third generation platform. Mr. Musk has confirmed that "Gen 3" will be a compelling electric vehicle with a base price of about $35,000 and a driving range of about 320 km. It is probably four years away.

Think about it: A vehicle comparable to a BMW 3 series, but at a lower sticker price and with free "fuel" for road trips. I think people will be lining up to buy them. If Tesla can deliver on its promises, it should be able to sell several hundred thousand Gen 3 vehicles per year.

Skeptics say Tesla won't be able to meet its price target. However, the success of the Model S is compelling evidence that Mr. Musk is capable of making his vision a reality. "I still feel pretty good about [Gen 3]," he said last week. "There is a huge amount of work, but no miracles required."

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I mentioned free fuel for road trips. All Tesla cars that roll off the production line include supercharging technology. A visit to a Tesla Supercharger station on the side of the highway costs you nothing and can replenish half of your charge in 20 minutes.

Tesla should have its U.S. supercharger network finished before the major car makers have anything similar to a Model S available, never mind a free-to-use charging network.

So the real bull story here is that Tesla could completely redefine the mid and high end of the automobile market in the next few years. It doesn't need to ship anywhere near as many cars as Ford or GM. It just needs to earn a seat at the player's table.

The bear case? There are a million things that can go wrong, and any hiccups could knock the stock down 50 per cent in a heartbeat. Tesla is a risky investment.

Bottom line: This is a stock that already prices in global success in the luxury market, but has room to rise if it is equally successful in the mid-priced market. All things considered, I'm holding onto my shares in hopes Tesla can become the next BMW. I expect a bumpy ride. The potential prize is worth it.

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About the Author

Chris Umiastowski, P. Eng., MBA, has over a decade of professional experience analyzing technology stocks as a former top ranked equity analyst on Bay Street. Prior to that, he worked as an engineer in the telecom industry. His deep technology and analytical experience help him identify investment opportunities that come from sweeping change in tech-centric industries. More

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