Why Tesla is 10 best stocks to buy now - Motley Fool (Part 1/2)
The article pointed out that bears were wrong to consider Tesla stock overvalue based on P/E ratio. It used a more accurate PEG ratio benchmark to explain Tesla stock is cheap if you factored in growth. Despite the article is written a year ago, it is still relevant.
Flaw in P/E Ratio
The flaw with the P/E ratio though is that it ignores a company's future growth, which is often the most important factor in determining its value. Tesla, for example, currently has a P/E ratio around 96, but it's expected to grow revenue by 59% this year, and earnings per share is forecast to jump 79% to $12.11, giving it a more reasonable forward P/E of almost 60.
The flaw with the P/E ratio though is that it ignores a company's future growth, which is often the most important factor in determining its value. Tesla, for example, currently has a P/E ratio around 96, but it's expected to grow revenue by 59% this year, and earnings per share is forecast to jump 79% to $12.11, giving it a more reasonable forward P/E of almost 60.
PEG ratio better way to measure growth
The best way to measure both price-to-earnings and growth is with the PEG ratio, a favorite metric of famed hedge fund manager Peter Lynch... Since high P/E companies tend to have high growth rates, the PEG is a good way to compare valuations of both high- and low-growth stocks.
The best way to measure both price-to-earnings and growth is with the PEG ratio, a favorite metric of famed hedge fund manager Peter Lynch... Since high P/E companies tend to have high growth rates, the PEG is a good way to compare valuations of both high- and low-growth stocks.
Why Tesla stock is still considered cheap?
Lynch theorized that an accurately valued stock would trade at a PEG of 1, while a PEG over 1 would indicate the stock was overvalued, and a PEG under 1 would mean that it's undervalued... As P/E ratios have inflated, so has the PEG, and a PEG of 1 no longer seems like an accurate benchmark.
At recent prices, Tesla trades at a moderate PEG of 1.66. That ratio actually makes the stock cheaper than the average stock on the Dow Jones Industrial Average, which has a PEG of 2.41.
Not only does the average Dow stock trade at a significantly higher PEG ratio than Tesla, but 19 of the 26 companies above are also more expensive than Tesla based on the PEG ratio. In other words, when you factor in growth, Tesla is cheaper than your typical blue-chip stock.
Factors support Tesla is a growth stock
Tesla is the clear leader in EVs, penetrating a massive addressable market that will take shape over the next 10 or 20 years. A lot can change during that time, and competition is likely to rise, but given Tesla's early leadership and brand strength, it's the clear favorite in the industry. Bears will surely continue to knock the stock. But at this point, if you're arguing that it's overvalued, the numbers simply don't back that up.
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I reflected trading experiences by writing journals. My comments are for educational purposes not financial advice.
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