Relative to What?
To determine if Tesla (TSLA) is overvalued, the first step is to set a benchmark for comparison. It's important to compare Tesla to something else since it has to be overvalued or undervalued relative to something. In this article, we'll compare Tesla to Toyota and the stock market to see if it's overvalued.
How NOT to Value Tesla
Some analysts compare Tesla's market capitalization (market cap) to other car companies. Tesla's market cap is currently ~$474 billion and Toyota's is ~$192 billion. These analysts argue that Tesla is overvalued because its market cap is more than 2x that of Toyota's, despite Toyota selling more than 10x as many vehicles as Tesla in 2021.
A slightly more sophisticated analyst may compare Tesla's price-to-earnings (PE) ratio to those of other car companies, like Toyota, and the S&P 500 Index (SPY). Tesla's PE ratio is 48.78, Toyota's is 10.48, and the S&P 500's is 20.80. A lower PE ratio is generally considered to be better. Some analysts may argue that Tesla is overvalued because its PE ratio is higher than those of Toyota and the stock market, but they're looking at the wrong ratio.
How to Value Tesla
The correct way to quickly determine if Tesla is overvalued is to look at its price/earnings-to-growth (PEG) ratio. The PEG ratio takes expected earnings growth into account. If a company is growing rapidly, its PEG ratio will be lower. Tesla's PEG ratio is 1.28, Toyota's is 3.73, and the S&P 500's is 4.16 (assuming 5% growth). A lower PEG ratio is generally considered to be better.
However, there is a risk associated with using PEG ratios because they are based on expected growth, which can be difficult to predict accurately. That's why we also perform fundamental, technical, and macroeconomic analyses, and factor in a margin of safety.
Is Tesla Overvalued?
No, Tesla is undervalued relative to our benchmarks, Toyota and the S&P 500, based on their PEG ratios.