Fooled by numbers

I teach an investing and personal finance class at a local high school. Every few weeks the kids are required to make a stock pick and pitch their idea to the class. They are getting pretty good at it.

But there are some stumbles. We are almost to the end of the semester, and despite my best efforts many of them are still anchoring to stock price instead of market cap or valuation.

I get it. A $2 stock with a $1 billion market cap feels “cheaper” than a $100 stock with a $30 million market cap. And that’s without even thinking about valuation.

I assure you we’ve talked about it quite a bit. Yet the focus on a stock’s price per share keeps creeping back into the conversation. Perhaps it is a reflection of my (lack of) teaching skills. (If you would like to make a donation to the school to help them afford better instructors you can do so here. Keyword “louisanerd” in the comment section.)

But perhaps I am being too hard on the kids. Focusing on price is hardly limited to high schoolers. I’m sure I do it sometimes. And some of the most widely-followed professional analysts also fall into the trap.

Ark Invest, the champion of the most recent bull market, has updated its model for Tesla post-earnings. The firm’s expected value for Tesla is $2,000 per share by 2027. For context, Tesla is at $162.99 heading into trading Friday as I write.

Some caveats here before we go further:

• Bashing Ark Invest, and its founder Cathie Wood, has become a bit of a parlor game. I hope not to do that here. I don’t necessarily agree with Wood or Ark on a lot of things, but I respect the hustle and I don’t think it is fair to pile on her for playing a game a lot of people play simply because she plays the game better than most.

• I’m guessing that by the time this publishes there will be thousands of deep dives into the Ark report so not going to go through it line by line. That’s what Twitter is for.

• This is not meant as advice on whether to buy, sell, hold, or short Tesla shares. Only a comment on one particular price target. My personal call on Tesla is “ignore.” I don’t want to own it, and I don’t want to short it. If the last 10 years have taught me anything, Tesla’s future price movement is about as predictable (to me) as Bitcoin.

Also, even without getting into the danger of focusing on price per share, it should be noted that $2,000 is a pretty remarkable target. That implies a 12x return in five years. And while yes, it is true Tesla has been a volatile stock that has shot to the moon at times, it has never come close to shooting to the moon like that.

I’ll admit that as a general rule, I get nervous any time I see a price target 12x above where things stand today. It is hard to run a market-beating business. I’d also note that the $2,000 target is just a base case for Ark. Its bull and bear models are perhaps more remarkable. The bull case is for a price of $2,500 per share by 2027. 15x. But the real wow one to me is the bear case target is $1,400.

Let that sink in for a moment. In Ark’s model, even if things go terribly wrong over the next five years, Tesla will still be an 8x winner over that time. Dear reader, I humbly submit to you that if someone tells you that even in the worst-case scenario a stock is going substantially higher from here, you should run in the opposite direction.

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So, how did we get here? Why is Ark so comfortable going way out on the limb here? I’d suggest that it is a focus on price per share that is the enabler.

For one, our brains like to play tricks on us. Not too long ago, Tesla was a $2,000 stock. Of course, that was before stock splits so it isn’t an apples to apples comparison to now. That chart above pretty clearly illustrates that. But in our heads, based on our recent memory, the idea of Tesla as a four-figure stock is not preposterous.

It seems a little less real if you think of it in terms of market cap. Should Tesla shares hit Ark’s 2027 price target, and based on its current share count, the company would be valued by the market at $6.3 trillion. At the high end, Tesla’s 2027 market capitalization would be $7.9 trillion.

$6.3 trillion. I might sound old fashioned, but that seems to me to be an awful lot of money.

Today, looking around the globe, there are five companies with market capitalizations north of $1 trillion. Apple leads the way ($2.6 trillion), followed by Microsoft, Saudi Aramco, Alphabet, and Amazon.

I’m not sure how best to compare all of this. There’s some fuzziness comparing current-day valuations to five years out. Inflation could get really out of control in the years to come, though not sure that would be bullish for an automaker. But in simple terms, the baseline case for Ark is for Tesla to be the approximate size of Apple, Microsoft, and Saudi Aramco combined. In five years.

In Ark’s defense they do mention market cap in the report. Towards the bottom of the page, in a chart. Obviously, they are not blind to this. But there is nothing to suggest it is a focus.

So, what’s the takeaway here? For one, I have no idea if Tesla shares will or won’t be worth $2,000 apiece by 2027. At best, I have a from-the-hip opinion or wild guess. To some extent all price targets are a naive attempt to predict the future. Ark could end up being spot-on. Or they could be way off.

The interesting thing to me isn’t the price target, it is the context. Even with my jaded eyes, the idea that Tesla shares could hit $2,000 in the next five years is a lot less incredulous than the idea that Tesla will be worth $6 trillion in five years. Even though it is the exact same valuation.

I guess I should go easier on my students. They are hardly alone in getting lost in a haze around price per share.

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