Tesla (NASDAQ: TSLA) receives a lot of media attention thanks to its high-profile founder and high-quality products. That translates into momentum in the stock market, but there are other big companies that fly somewhat under the radar. Consider two other powerhouses with cheaper valuations and sustainable competitive advantages to unlock long-term growth.
Where will Tesla be in ten years?
Tesla earned a place in the heralded “Magnificent Seven,” disruptive technology powerhouses that have fueled market index performance for much of the past two years. Investors are enamored with Tesla’s meteoric rise in the auto manufacturing industry and its dominant leadership in the emerging electric vehicle (EV) market.
Tesla stock has been one of the market’s biggest success stories for years, but investors are questioning that narrative as they reconcile positive expectations with the company’s financial results. Economic cycles and business maturation have disrupted Tesla’s growth and profitability, creating uncertainty about future cash flows.
Tesla’s total revenue grew 2% last quarter, while car sales fell from the previous year. The shortfall was offset by growth in the energy storage segment. The gross margin on car sales fell from 17.5% to 13% last year. This is a worrying sign that points to lost pricing power.
The drastic reduction in margins could reflect the timing of certain model launches and aggressive pricing responses to macroeconomic conditions, but the increasing threat of competition could play a crucial role. The deterioration in gross profit caused Tesla to report lower operating profits. Capital expenditures continued to rise, putting pressure on free cash flow on both sides of the equation. Investors generally don’t look favorably on companies with small margins and volatile prices and gross profits, so the recent trends are discouraging.
Tesla still dominates the global EV market, but that leadership is under attack. Market share recently fell below 50% as several major manufacturers caught up. The country is losing ground in the field and the impact of its status as a ‘first mover’ appears to be waning. The prospect of price-competitive alternatives from China also casts an ominous shadow.
None of these factors are necessarily insurmountable problems. On the face of it, Tesla makes a high-quality product, it’s growing and profitable, it’s maneuvering effectively through a tough sales environment, and it’s still at the top of a growth industry. Unfortunately for shareholders, all of these favorable qualities are already factored into the share price.
Tesla’s market capitalization is $830 billion. The forward price-to-earnings ratio is over 70 and the price-to-sales ratio is 9.5. Both are expensive and do not match the growth rate of the company. The company’s financial returns would need to increase by more than 30% to bring the PEG ratio more in line with the future price-to-earnings ratio. That could happen, but the threats to pricing and growth outlined above will be challenges. Investors can find high-quality stocks with more upside potential elsewhere in the market.
First stock to watch: Visa
Visa (NYSE:V) is one of the largest and most successful fintech companies. It tops a shortlist of peers as the world leader in card payment processing. Payments technology has been ripe for innovation in recent years, but Visa has managed to embrace emerging technologies to support its growth despite the disruption.
Blockchain and PayPal appears to be a major threat, but Visa continues to expand along with global commerce. It has managed to thrive as the fintech world changes around it.
Visa’s dominance is so great that it has recently come under scrutiny by regulators. The Justice Department recently sued the payment processor for a monopoly in the debit card market, driving up prices for consumer goods across the board. Visa has rejected the validity of the lawsuit, but it seems likely that there will be a compromise on the fees charged to merchants for debit card transactions. That’s a challenge for growth from current levels, but the long-term catalysts are still at play.
Visa’s scale and technology base allows it to provide reliable, low-cost and efficient transaction services. This contributes to a strong brand and makes it exceptionally difficult for competitors to offer superior quality or a more favorable price. That’s the foundation of an economic moat that should protect the growth trajectory of Visa’s future cash flows.
The fintech leader’s $554 billion market cap would need to rise 65% to match Tesla’s market cap. Visa’s forward price-to-earnings ratio is 24, which compares favorably to the 10% growth rate in the most recent quarter. Of course, capital market conditions ultimately determine the performance of stocks in general, but Visa stock should continue to rise higher relative to the market as cash flows increase.
Second stock to watch: Taiwan Semiconductor Manufacturing
Semiconductor stocks are notoriously cyclical, and industry leaders such as Nvidia And Broadcom have been caught up in the AI frenzy over the past two years. These forces can promote volatility, making it difficult to predict stock prices.
Taiwanese semiconductor manufacturing (NYSE: TSM)also known as TSMC, is a broader bet on the microchip industry as a whole. TSMC provides outsourced manufacturing services for many of the largest chip manufacturers. Investors have seen several semiconductor powerhouses rise and fall due to changing trends in technology and computing. Every few years, new generations of chips enter the market, which can quickly shake the market share.
While its customers rise and fall, TSMC remains the go-to for manufacturing. It has somewhere between 50% and 60% of the global chip foundry market. The company’s prospects are essentially tied to long-term demand for semiconductors and the avoidance of catastrophic geopolitical conflicts in East Asia. There are undoubtedly risks on each of these fronts, but the overall outlook is promising at this point.
TSMC’s market cap is almost $930 billion, so it’s already worth more than Tesla. The chip foundry overtook the EV manufacturer earlier this year and is in a strong position to maintain that position.
TSMC’s compound annual growth rate has been around 17% over the past five years, with cash flow growing even faster. It’s not fair to assume this pace will continue over the next decade, but the stellar performance combined with the prospects for the semiconductor industry make it unlikely the company will slow down.
TSMC’s forward price-to-earnings ratio is below 25, so it faces much lower hurdles than Tesla to meet investor expectations. This makes it a strong candidate to remain more valuable than the dynamic EV maker.
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Ryan Downie has positions in Nvidia and Visa. The Motley Fool holds positions in and recommends Nvidia, PayPal, Taiwan Semiconductor Manufacturing, Tesla, and Visa. The Motley Fool recommends Broadcom and recommends the following options: Short December 2024 $70 calls on PayPal. The Motley Fool has a disclosure policy.
Prediction: 2 Stocks That Will Be Worth More Than Tesla in Ten Years Originally published by The Motley Fool
