Does This Valuation Of Tesla, Inc. (NASDAQ:TSLA) Imply Investors Are Overpaying?

Key Insights

• Tesla's estimated fair value is US$178 based on 2 Stage Free Cash Flow to Equity
• Current share price of US$235 suggests Tesla is potentially 32% overvalued
• The US$236 analyst price target for TSLA is 33% more than our estimate of fair value

Today we will run through one way of estimating the intrinsic value of Tesla, Inc. (NASDAQ:TSLA) by taking the expected future cash flows and discounting them to today's value. Our analysis will employ the Discounted Cash Flow (DCF) model. Believe it or not, it's not too difficult to follow, as you'll see from our example!

We generally believe that a company's value is the present value of all of the cash it will generate in the future. However, a DCF is just one valuation metric among many, and it is not without flaws. For those who are keen learners of equity analysis, the Simply Wall St analysis model here may be something of interest to you.

View our latest analysis for Tesla

Step By Step Through The Calculation

We are going to use a two-stage DCF model, which, as the name states, takes into account two stages of growth. The first stage is generally a higher growth period which levels off heading towards the terminal value, captured in the second 'steady growth' period. To begin with, we have to get estimates of the next ten years of cash flows. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

Generally we assume that a dollar today is more valuable than a dollar in the future, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) forecast

	2024	2025	2026	2027	2028	2029	2030	2031	2032	2033
Levered FCF ($, Millions)	US$9.05b	US$14.1b	US$16.4b	US$32.3b	US$41.6b	US$50.3b	US$57.9b	US$64.5b	US$70.0b	US$74.7b
Growth Rate Estimate Source	Analyst x17	Analyst x15	Analyst x7	Analyst x4	Est @ 28.77%	Est @ 20.81%	Est @ 15.23%	Est @ 11.33%	Est @ 8.59%	Est @ 6.68%
Present Value ($, Millions) Discounted @ 10%	US$8.2k	US$11.6k	US$12.2k	US$21.7k	US$25.3k	US$27.7k	US$28.9k	US$29.2k	US$28.7k	US$27.7k

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = US$221b

We now need to calculate the Terminal Value, which accounts for all the future cash flows after this ten year period. For a number of reasons a very conservative growth rate is used that cannot exceed that of a country's GDP growth. In this case we have used the 5-year average of the 10-year government bond yield (2.2%) to estimate future growth. In the same way as with the 10-year 'growth' period, we discount future cash flows to today's value, using a cost of equity of 10%.

Terminal Value (TV)= FCF₂₀₃₃ × (1 + g) ÷ (r – g) = US$75b× (1 + 2.2%) ÷ (10%– 2.2%) = US$931b

Present Value of Terminal Value (PVTV)= TV / (1 + r)¹⁰= US$931b÷ ( 1 + 10%)¹⁰= US$345b

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is US$566b. In the final step we divide the equity value by the number of shares outstanding. Compared to the current share price of US$235, the company appears potentially overvalued at the time of writing. The assumptions in any calculation have a big impact on the valuation, so it is better to view this as a rough estimate, not precise down to the last cent.

Important Assumptions

We would point out that the most important inputs to a discounted cash flow are the discount rate and of course the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at Tesla as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 10%, which is based on a levered beta of 1.642. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for Tesla

Moving On:

Whilst important, the DCF calculation is only one of many factors that you need to assess for a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For instance, if the terminal value growth rate is adjusted slightly, it can dramatically alter the overall result. Can we work out why the company is trading at a premium to intrinsic value? For Tesla, we've compiled three relevant aspects you should explore:

1. Risks: For example, we've discovered 1 warning sign for Tesla that you should be aware of before investing here.
2. Management:Have insiders been ramping up their shares to take advantage of the market's sentiment for TSLA's future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
3. Other Solid Businesses: Low debt, high returns on equity and good past performance are fundamental to a strong business. Why not explore our interactive list of stocks with solid business fundamentals to see if there are other companies you may not have considered!

PS. Simply Wall St updates its DCF calculation for every American stock every day, so if you want to find the intrinsic value of any other stock just search here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.