On April 22, 2025, just after Tesla’s stock price closed at $237.97, the company reported that its first quarter earnings had declined by 71% from its corresponding value a year before. When the market reopens on April 23, traders will express their collective judgment about the degree to which Tesla’s market cap has moved toward its fundamental counterpart.
A year ago, in April 2024, Tesla’s stock was trading at $166 per share. At the time, the analysts at JPMorgan estimated that the fundamental value of Tesla’s stock was about $100 per share, based on a discounted cash flow technique. In a previous post, entitled “How Overvalued Is Tesla’s Stock, Really?” I provided a critique of the JPMorgan analysis, and suggested that Tesla stock’s fundamental value was closer to $30 per share.
Tesla’s stock price is driven more by market psychology, sentiment, than by fundamentals. This, I suggest, is why Tesla’s stock rose to $488 in the second half of 2024, before falling back to $238.
As investors digest the information about Tesla’s first quarter earnings decline, they might benefit from giving appropriate weight to some key fundamental statistics about Tesla’s financial history and situation.
The analysts at JPMorgan assume that Tesla’s cost of capital is about 12%. This strikes me as a plausible figure. For most of the years since Tesla bee, it earned less than its cost of capital. Only in 2021, 2022, and 2023 did it earn more than its cost of capital. Companies that consistently earn less than their cost of capital eventually disappear.
The analysts at JPMorgan, despite their pessimistic outlook for Tesla’s stock, nevertheless implicitly assume that Tesla will earn more than its cost of capital in the long-term. This assumption only makes sense if Tesla maintains a competitive advantage in the long-term. Tesla’s first quarter earnings decline is consistent with the possibility that the company is losing its competitive advantage.
Tesla’s free cash flows turned negative in 2023, and have stayed negative since that time. Free cash flows are the basis of fundamental value. When free cash flows are negative, the direction of cash flows is from a company’s investors, the debtholders and shareholder, to the company. Those investors would prefer that the cash flow to them, not from them. The surge in Tesla’s stock price during the second half of 2024 suggests that investors attach little significance to free cash flow forecasts.
Return on capital and free cash flow lie at the heart of a company’s fundamental value. If Tesla cannot earn more than its cost of capital going forward, the fundamental value of its stock is arguably about $30 a share. If at some point, investors decide that cash flows are what is really important about Tesla, then the market price of its shares will move to its corresponding fundamental value. If that happens in the near future, Tesla’s stock will decline by more than 85% from its recent value of $237.