Ron Baron’s Tesla Predictions Versus the Base Rate

On Tuesday Ron Baron appeared on CNBC and made some bold Tesla (TSLA) predictions.

Ron Baron’s Tesla Predictions

To summarize, Ron Baron believes in 2.5 years Tesla will achieve the following.

  • By 2020, Tesla’s share price will be $1,000
  • By 2020, Tesla will have $70 billion in revenue
  • By 2020, Tesla will sell 1 million cars per year
  • By 2020, Tesla will have $10 billion in operating profit

Tesla (TSLA) is already a large holding for Ron Baron and his fund company Baron Asset Management. Tesla’s stock has done well for them since their purchase in 2014. Because of this, Ron is making his predictions from an Inside View.

Sales Growth from the Inside View

Ron is focusing too much on how unique he believes Tesla to be.

This is not to say Ron and his team did not create financial models, develop forecasts for Tesla’s potential total addressable market, and predict Tesla’s future market share.

They did.

But they made their models and assumptions from an Inside view. The Inside View is prone to overly optimistic assumptions and overconfidence in one’s own abilities.

Ron Baron believes Tesla will grow its trailing twelve-month sales from $8.55 billion to $70 billion in 2.5 years. A compound annual growth rate of 131%.

Maybe Tesla achieves this.

But did anyone at Baron Asset Management ask, “In the history of publicly traded companies, across all sizes and industries, how many companies were able to grow their sales at a compound annual growth rate of 131% over 2.5 years?

Sales Growth from the Outside View

Michael Mauboussin and his team at Credit Suisse created the Base Rate Book to help with the outside view. The Base Rate Book addresses our sales questions above.

Sales Base Rate
Table from The Base Rate Book

Only 2.5% of all companies since 1950 have achieved a compound annual growth rate over 45% during a 3-year time span.

I’m willing to bet this rate drops below 1% for a CAGR greater than 100% over 3 years.

An even better Outside View is to see how many companies with sales numbers similar to Tesla’s have achieved a compound annual growth rate greater than 45% for 3 years?

Outside View for $7-12 Billion in Sales

The Base Rate Book also has sales data broken down into smaller cohorts.

Tesla had $8.55 billion in trailing twelve months sales which places it in the $7-12 billion sales cohort.

Base Rate
Table from The Base Rate Book.

Only 0.7% of companies with $7-12 billion in existing sales were able to achieve a compound annual growth rate greater than 45% over 3 years.

Goal of the Fundamental Investor

From the introduction to the Base Rate Book

The objective of a fundamental investor is to find a gap between the financial performance implied by an asset price and the results that will ultimately be revealed. A useful analogy is pari-mutuel betting in horse racing. The odds provide the probability that a horse will win (implied performance) and the running of the race determines the outcome (actual performance). The goal is not to pick the winner of the race but rather the horse that has odds that are mispriced relative to its likelihood of winning.

As a result, investing requires a clear sense of what’s priced in today and possible future results. Today’s stock price, for example, combines a company’s past financial performance with expectations of how the company will perform in the future.[emphasis added]

The fundamental investor needs to compare their Inside View assumptions to the Outside View.

The fundamental investor needs to ask what has happened to other similar companies in this situation. Then determine if the current stock price and its implied assumptions represent a mispriced bet or an overpriced bet?

Is Tesla a Mispriced Bet or an Over Priced Bet?

Tesla’s share price is trading at an all-time high near $380 per share. Tesla’s current market capitalization is $62 billion. This is greater than Ford’s at $44 billion and General Motors’ at $52 billion.

GM Market Cap Chart

GM Market Cap data by YCharts

Ford and GM’s trailing twelve-month revenues are $153 billion and $170 billion respectively. Tesla had $8.5 billion.

GM Revenue (TTM) Chart

GM Revenue (TTM) data by YCharts

Ron Baron is predicting Tesla will grow its sales at a compound annual growth rate of 131% over the next 2.5 years.

Only 0.7% of companies with $7-12 billion in existing sales has ever achieved a CAGR above 45% over 3 years since 1950.

Given Tesla’s current share price, market capitalization, and implied assumptions about its future does Ron Baron’s bet look mispriced or over priced?

What I Wish I Wrote ~ June 2, 2017

This is a great twitter thread on how Amazon is disrupting consumer brands and which items are most likely to be disrupted.

And as a follow-up, the presentation from the 2017 Ira Sohn Conference on why Energizer Holdings (ENR) is a short. (Ira Sohn)

The Invest Like the Best Episode with Royce Yudkoff and Rick Ruback focuses on buying small highly profitable businesses in a model they call Really Private Equity. The criteria they look for in an acquisition candidate are equally applicable when looking for a publically traded company. Especially when they talk about recurring versus repeating revenue.

“More money has been lost reaching for yield than at the point of a gun.” If you’re investing in a high yielding retail stock, how safe is that dividend? (A Wealth of Common Sense)

Which would you rather own a Ferrari or a Tesla? Now, which stock RACE or TSLA? If you’re a Return on Invested Capital fan then Ferrari is your pick for both. Plus, RACE pays a dividend. (Intrinsic Investing)

Autonomous cars are coming. When exactly? I don’t know. But LIDAR will the be key. A brief introduction to LIDAR (Voyage)

Pepsi (PEP) dividend growth analysis (The Dividend Groth Investor)

The iPhone has a tremendous loyalty and retention rate in the U.S. and around the world. Except in China. The Chinese smartphone user is driven by WeChat and Apple needs to find a solution to this issue. (Stratechery)

On position sizing in your portfolio (Covenant-Lite on Medium)

Got 11 hours to listen to some music? The complete history of Punk Rock in 200 tracks. (Open Culture)

Tesla & Electric Vehicles: Disruption Usually Takes Much Longer Than We Think

The Box is a great book that I read after Bill Gates recommended it a couple years ago. It is the story of how container shipping took over the world.

One of the lessons I learned from the book is that it takes far longer for a disruptive technology to take over than people think. The more capital intensive the industry, the longer it will take.

The shipping industry is extremely capital intensive. Although the huge cost savings of container shipping were pretty much evident right from the start, it took a really long time, decades, for container shipping to completely take over. New ships, ports, and containers all had to be built to meet the rising demand.

An industry starting to see some disruption is the car industry with ride-sharing apps, self-driving cars, and the shift away from internal combustion engines to alternative power sources like all electric vehicles.

The car industry is another capital intensive industry. The disruption of the car industry will take far longer than we’re expecting. Matthew Lewis in the following “tweetstorm” about car use and the climate hits on a couple of reasons why EV adoption rates will be lower than some expectations.

We, people as a whole, are really good at creating expectations that far exceed precedents. If the past disruption of other capital intensive industries provides any lessons, it’s we’re grossly overestimating how quickly the car industry will be disrupted. Especially when it comes to replacing the internal combustion engine with alternatively powered cars like Electric Vehicles.