Paper argues that skyrocketing valuations for the likes of Tesla will end in failure
While it’s tough to argue against the fundamental ESG-driven investment thesis supporting the electric vehicle industry, investors buying into the narrative shouldn’t get too carried away, according to a new paper.
The paper, written by Rob Arnott and Lillian Wu of Research Affiliates along with Bradford Cornell of the University of California, noted that the total market value of eight electric vehicle specialist companies had swelled 618% in a year, reported Institutional Investor.
“The electric vehicle industry, with its astronomical growth in market-cap over the 12 months ending January 31, 2021, is a prime example of a big market delusion,” the three wrote in the paper.
By the end of January, those eight names had a combined market value of US$1 trillion – the lion’s share was from Tesla, which had a market cap of US$752 billion – putting them within striking distance of the US$1.1 trillion value of traditional automakers as a whole.
To yield great fortunes for investors, the paper said, technology must be “associated with barriers to entry that allow a company to earn returns significantly in excess of the cost of capital for an extended period.” Unlike Apple, Google, and Facebook, it said that Tesla and other electric vehicle companies don’t have that type of protection.
“At that market capitalization, Tesla accounted for about 75 percent of the total EV group’s market value and 35 percent of the market value of the entire auto industry,” Arnott and his co-authors wrote. “Such an immense market capitalization makes sense only if the expectation is that Tesla will come to dominate the entire auto industry, not just the EV market.”
Bullish bets on Tesla should translate into bearish expectations on its competitors, they noted, which should bear out in the form of falling valuations. But the opposite has been true, the authors said; the prices of EV firms competing with Tesla have skyrocketed, and conventional automaker stock valuations have been “rising handily.”
“All of these companies are priced as if they are going to be huge winners, but they are competitors,” the authors said. “They cannot all assume dominant market share in the years ahead!”
The more likely trajectory, they said, would trace the path of previous booms in the auto sector, technology, or airlines, the latter of which was characterized by “virtually every company in the business either [failing] or [merging] into other a larger airline, most of which also collapsed.”
“We suspect that as EV competition heats up, many companies will fail … and with time the total value of the industry will recede to more reasonable levels,” the authors said.
