Will Tesla hit $3,000, or are you better off investing elsewhere?

Cathie Wood, one of the world’s most successful fund managers, reckons that Tesla’s share price will hit $3,000 by 2025. For perspective, it’s currently sitting at just over $650 after a bumpy start to the year. Is Wood right, or are her claims just the latest evidence that Tesla – and the wider electric vehicle sector in general – is one massive bubble waiting to collapse?

Cathie Wood’s latest emphatic endorsement of Tesla came in a report from her asset management company Ark Invest on Friday. Tesla’s share price reacted as you might expect, jumping by as much as 6% on Monday this week.

Wood is very much in favour at the moment, having made huge returns for investors in recent years. Ark has proved very successful with its range of seven thematic exchange-traded funds (ETFs) – stockmarket-listed funds set up to take advantage of a specific sector or theme. In Ark’s case, it specialises in making aggressive bets on growth stocks, and that of course has paid off handsomely over recent years. So it’s no surprise that Tesla is the top holding across all of Ark Invest’s funds.

Investors may also be inclined to take notice of this price target because it’s not the first time Wood has made an eye-watering-yet-accurate prediction for Tesla’s stock. In 2018, Wood made what many would have considered a wild bet – that Tesla would trade at $800 a share within five years (the target was $4,000 at the time, but Tesla went through a five-for-one stock split last August, so we’ve adjusted for that).

At the time she made the forecast, Tesla’s price (adjusted for the split) was just $250 per share. It raced past her $800 target in January this year, two years ahead of schedule. So what’s next for Tesla? Why is she so bullish?

Again, it’s all about “disruption”. Wood’s latest price target assumes (in part) that the electric car producer will launch an autonomous robot taxi service. “In preparation for its robo taxi service, Tesla could launch a human-driven ride-hail network first, delivering a highly profitable recurring revenue stream and limiting the downside of a failed autonomous service. A human-driven ride-hail service could boost Tesla’s price target in ARK’s bear case significantly”, Wood says.

Even in a worst-case scenario, Wood expects Tesla to trade at $1,400 by 2025 (ie more than doubling from here) and in the best-case scenario, sees the stock hitting $4,000. Wood has been right before, and her short-term record is excellent. Should investors pay attention to her this time around?

The entire global car market is in the grip of a “big delusion”

During 2020, several factors – from ultra-low interest rates to Tesla’s status as a bit of a “meme” stock, enthusiasm for all things electric and ESG to genuine progress in sales and manufacturing – helped drive the electric car group’s prices up by almost 700%.

So the fact that it has taken a bit of a hit since the start of this year isn’t necessarily surprising after such a strong run. However, even after the recent correction, it’s hard to argue that Tesla is a bargain. Or even priced reasonably.

Indeed, a report released earlier this month by Rob Arnott and colleagues at Research Affiliates argues that the whole electric vehicle sector is already pricing in too much optimism, never mind Wood’s $3,000 target. (The report is entitled, Big Market Delusion: Electric Vehicles, which gives you a good idea of the contents before you even get into it).

The first point they make is that by the end of January this year, the combined market capitalisation of the worldwide listed car industry grew by 70% to $2.16trn. But almost all of that gain has happened in the past year; in 2018 and 2019, traditional car makers fell in value, while electric car makers were flat.

What happened in 2020, after the market bottomed out in the wake of the pandemic, is that the share prices of electric car makers soared, even as sales for the vehicle industry as a whole fell. As a result, by the start of this year, the combined value of the traditional car manufacturers (Research Affiliates includes 37 companies here) was around $1.1trn, while the combined value of eight electric vehicle makers came in at almost as much – $1trn. And of that $1trn, Tesla alone accounted for about 75%.

Here’s the key point made by Arnott and team: for Tesla to be worth as much as it was at the start of the year (about $800 a share), it needs “to dominate the entire auto industry, not just the electric vehicle market”.

Not everyone can be a winner here

Even if you argue that the market is right to price that in, there’s a problem. Because if Tesla does end up dominating, the value of its direct competitors – all the other car manufacturers, both electric and traditional – should be falling to reflect this dominance. Instead, prices of all other electric vehicle groups have soared – as Arnott says, “the pricing delusion is not exclusive to Tesla” – and even traditional car manufacturers have risen, helped by their own electric-vehicle plans.

For example, German car manufacturer Volkswagen last week announced plans to build six electric-vehicle battery factories across Europe and make electric cars its main product by 2030, causing its shares to rally. VW said it plans to overtake Tesla as the leading manufacturer. Ford and General Motors have also witnessed higher prices after they merely showed greater willingness to participate in the electric vehicle sector.

What’s going on? Investors see an exciting new market, and they are just throwing money at it as if every company will be a winner, which clearly isn’t possible. In short, as Arnott puts it: “The hallmark of a big market delusion is when all the firms in an evolving industry rise together even though they are often direct competitors.”

The point is that electric cars may very well be the future. But at current levels, it’s already priced in and more. That’s why bulls on Tesla still need to rely on “jam tomorrow” stories – like robotaxis – to justify their ever-increasing valuations.

That’s worked while growth stocks have been in the ascendant and interest rates and inflation have remained low, for reasons we’ve discussed previously. But now the pendulum is swinging back towards value stocks. It may seem a little ironic, but the best bet for investors right now might not be electric cars, but the fossil fuel companies they threaten to make obsolete.

We’ll have a lot more on all of these topics in upcoming issues of MoneyWeek magazine. If you’re not already a subscriber, you can get your first six issues plus a beginner’s guide to bitcoin, absolutely free here.