In January 2020, Tesla, Inc. (TSLA) was valued at $117 billion by the stock market. By the end of the year, that figure had skyrocketed to $658.39 billion. Subsequently, Tesla's stock traversed the distance to a $1 trillion market cap in less than a year, reaching that milestone on Oct. 25, 2021.
The stratospheric rise in Tesla's shares within a short span of time has confounded investors. It also raises an important question: can the factors that propelled Tesla to a trillion-dollar valuation during the pandemic help sustain its momentum afterwards?
- The increase in Tesla's stock price and market cap has created a financial complex of investment products that include or track the electric car maker's stock.
- Average trading volume in Tesla options exceeds that in S&P 500 options.
- The financial complex has helped Tesla finance the next round of its evolution as a major car manufacturer.
The Tesla Financial Complex
While retail investors (and CEO Elon Musk’s tweets) have played a major role in Tesla's ascent, at the heart of the electric car maker's meteoric rise lies what the Financial Times terms a "Tesla financial complex." Included in this complex are an assortment of investment products—options, equity-linked funds, climate tech-focused investment vehicles—and they exert a massive influence in the equity and derivatives markets.
The relationship between the stock and members of this complex is symbiotic. As Tesla's stature grows in the markets, funds and derivatives with exposure to the stock generate outsized returns, leading fresh investors to pour money into it and further increase its influence. For example, in July 2018, the Tesla was a holding in 106 exchange traded funds (ETFs). By December 2021, it became a holding in 244 ETFs.
Tesla's entry into the S&P 500 in December 2020 has further exposed funds tracking the index to the company's stock, and they have reaped the rewards of its price run-up. The company joined the S&P 500 with a weighting of 1.6%. By the beginning of November 2021, it was weighted at 2.5% of the index and had contributed almost a quarter of the index's returns. A similar story played out in the Russell 1000, where Tesla accounted for 4% of the overall weighting in November.
In the Morningstar Consumer Cyclical Index, Tesla has contributed 27.98 percentage points to the index's 95.24% gain in the past two years. Online retail behemoth Amazon.com, Inc. (AMZN) was a distant second with a contribution of 16.92 points.
According to a recent report by investment firm Goldman Sachs, the nominal trading value of Tesla options averaged $241 billion a day in recent weeks. For context, average trading volume for the rest of the S&P 500 excluding Amazon was $112 billion. Goldman has attributed the explosion in options trading within the United States to Tesla, calling it a "critical driver of the market."
Typically, options are a risky bet on an underlying equity's future price movement. The leverage risk, inherent in most options, is reflected in a stock's price volatility. While Tesla's stock is prone to wild swings, its rise has also been accompanied by a corresponding change in the perception of risk in the markets.
The electric car maker's choppy ascent since its debut in the stock market in 2010 has frequently been punctured by short sellers, who claim that electric vehicles are expensive and have no future.
The pandemic changed that calculus. Intensifying debate about climate change coupled with the current administration's green subsidy push and record delivery numbers (although they still lag those of established car manufacturers by a wide margin) have helped push Tesla past the $1 trillion mark.
Should Investors Expect Further Gains?
During times of excess, fundamentals take a backseat. And so it has been with Tesla. Even though the company makes a fraction of the cars of its competitors such as Ford Motor Company (F) and General Motors Company (GM), it sported roughly five times their combined market cap in December 2021. Much of the heft in Tesla's valuation (and associated financial products) comes from the promise of a future dominated by electric vehicles. At present, that world does not exist, making Tesla's current valuation seem outlandish.
Drew Dickson, chief investment officer at Albert Bridge Capital, told the Financial Times that valuations nowadays are driven by a "huge, recursive 'tail wagging the dog' nature," meaning they are based on expectations of the future rather than present reality. "I'm unwavering in my belief that ultimately the fundamentals are what matters," he said.
While it has artificially inflated the company's valuation, the financial juggernaut machine behind Tesla's wild pandemic ride in the markets has also helped bolster the company's fundamentals. The flow of investors pouring money into Tesla's stock and associated financial products helped finance its investments into manufacturing infrastructure. The company's reliance on bonds, which require regular payments, has lessened.
Last year, Tesla issued $10 billion worth of new equity at prices that were approximately nine times that of 2019, to capitalize on demand for its shares. That capital infusion has helped the company inaugurate new factories in Austin and Berlin. Once they become operational, along with its factories in Fremont and Shanghai, the company should kickstart into high gear with its vehicle delivery.