Last May – when You’re here (NASDAQ: TSLA) the shares were trading at around $ 150 on a split-adjusted basis – CEO Elon Musk said on Twitter that the Tesla share price was likely too high.

Tesla share price is too high imo

– Elon Musk (@elonmusk) May 1, 2020

As Tesla stock continued to rise for the remainder of 2020 and maintained its massive gains, Musk began to change its tone. By the time Tesla held its fourth-quarter earnings call last week, the stock had more than quintupled from what Musk considered “too high” less than a year ago. Nonetheless, Tesla’s CEO explained why the imminent arrival of fully autonomous driving technology would justify the company’s high valuation.

There’s only one problem: Musk’s whole argument rests on a fallacy. We will take a look.

The math of Elon Musk

Tesla’s auto sales hit a record $ 27.2 billion last year, and the company earned a GAAP operating profit of $ 2 billion. Tesla expects dramatic growth from this base. It plans to increase its vehicle deliveries by around 50% per year on average in the short term, as it increases its battery and assembly capacity, locates production and launches new models.

Still, based on Tesla’s closing price on Wednesday of $ 864.16 and its diluted stock count of 1.124 billion shares, the company had a fully diluted market cap of nearly $ 1,000 billion. Even if Tesla were able to boost profits tenfold, that wouldn’t justify the company’s recent valuation without aggressive expectations of continued growth.

During Tesla recent earnings callMusk felt the stock remains reasonably priced when you factor in the potential for profit from the full self-driving capabilities Tesla is building.

… [I]f Tesla’s ships, say, hypothetically, $ 50 billion or $ 60 billion in vehicles, and those vehicles become fully autonomous and can be used … on average 60 hours per week. … [L]and let’s just assume the car becomes twice as useful … that would still be a doubling of the company’s revenue, which is almost entirely gross profit. … [I]It would be like … having $ 50 billion in extra profit basically because it’s just software.

In short, Musk argues that the FSD capability will make every car built by Tesla considerably more valuable, as it can be used more than a personal vehicle. Musk believes Tesla will capture that extra value as near pure profit, resulting in a massive profit inflection that would see the company make tens of billions of dollars a year in just a few years – with plenty of room to keep growing.

It’s a giant fallacy

Alas, this “plan” is built on a fallacy. First, while typical car owners may only spend 12 hours per week in their vehicles, actual taxis are used much more often. In New York City, for example, some taxis are used for double shifts and can run 100 hours a week (or even longer). These vehicles do not have more value simply because they will be used more: production costs determine the selling price of the vehicle more than the intended use.

Second, Statista estimates that the global taxi and ride-hailing market will reach $ 260 billion this year. This represents a huge opportunity, but reaching $ 50 billion or more in revenue will not be easy. It will take time for the robotaxis to disrupt the traditional ridesharing and taxi markets. And even when they do, Tesla will face a lot of competition, as there are plenty of other companies hoping to roll out robotaxi services as well.

Robotaxi services can generate higher margins than car manufacturers in the long run. However, Musk’s implicit assumption that Tesla could double its revenues with minimal additional costs – thereby earning pre-tax margins of 50% or more – is clearly wrong. If Tesla set its robotaxi prices high enough that it could earn such high margins, competitors would undermine its pricing and steal its market share. This competitive dynamic will severely limit the opportunity for additional profit resulting from the use of Tesla as a robotaxis.

Turning to the core business for Tesla’s value

Many Tesla bulls expect the company to become the largest automobile manufacturer in the world within 10 or 15 years, delivering 10 million cars or more per year. If Tesla can achieve this while achieving double-digit automotive operating margins and creating lucrative side businesses in solar power, batteries and robots, Tesla stock could certainly reach its valuation over time. time.

However, investors should not rely on robotaxis as a silver bullet that will make Tesla massively profitable overnight. Tesla may develop a nice robotaxi business in parallel, but the growth of the core auto business will determine whether Tesla stock continues to soar or fall back to earth over the next decade.