Tesla PS Ratio & The Coming “Tax” on Index Fund Owners

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The results are sorted by their weighting in the index from largest to smallest. At a 6.97% weight, Apple is at the top. To the right of each stock are 100s of columns of data showing the various metrics we calculate to measure valuation and firm health. The spreadsheet is our most basic. The fuel for our model portfolios designed to exploit investors’ documented behavioral errors. These errors manifest themselves in inefficient markets. Despite the recent correction, the opportunities for active managers are still vast. Predictably, the fanaticism of indexing has created a toxic brew for its adherents. We believe cheap beta is an incredibly important tool. But a disciplined active manager has only had it easier at the peak of the dot.com bubble. Let us explain: The top 10 stocks in the S&P 500 represent 29.7% of the index. Nearly a third of every dollar you invest in that index is going into just ten stocks. The value-weighted average price to sales ratio is 7.3x. Madness. Tesla stock price to sales ratio is the number one contributor to that offensive valuation metric. The vaunted maker of electric vehicles sported a 14.5x multiple with a 2.44% weight in the index. What follows is not an indictment of Tesla. Instead we take umbrage that the Tesla PS ratio and that of other overpriced stocks in the index. We offer another simple question to the index-funds-only crowd: why the dogma? This newsletter has generated massive empirical evidence around the idiocy of paying 10x sales for a stock. Scott McNealy’s quote on Sun Microsystem’s stock is the “anchor” concept. Very simply: Tesla's PS ratio of 10x is too much! The chart below shows the weighting in the S&P 500 Index of stocks valued at over 10x P/S. For any advisor or FA who has bought into the dogma of “only indexes” we ask you: do you think having dot.com levels of painfully inappropriate valuations in your clients’ portfolios is a good idea? If so, why? Tesla's Valuation Today: The Price to Sales Problem Looms Large As most investors have noticed, markets have begun to fall. After what some have suggested are 40 years of ever-larger policy mistakes, the bill is coming due. With CPI soaring, the Fed halted their “QE” and suggested they would be selling $95bn of assets per month in a tapering function to shrink their bloated balance sheet. $95bn sounds like a lot of money until you remember their balance sheet is $9 trillion. Just hitting the “pause” button on the buying with a miniscule rate hike has sent stocks and bonds into a spiral. We are glad we are not the Fed. Recession, inflation or some ugly combination seems increasingly likely. Cramer hosts folks calling a market bottom while others suggest the losses will continue. This newsletter and the investment products run by the Fund Managers who author this work, do not time markets. Plenty of other ways for us to look foolish. We do, however, believe in algebra and the lessons of financial history. Valuation is a horrible timing tool but, as we have shown, it has been a remarkably effective forecaster of realized 10 year forward returns. By November of 2021, Buffett’s market cap to GDP metric had hit an incredible 234%. A level that swept past the previous peak of reckless speculation in 2000. As the chart below shows, the sell-off to date has cut valuations to 184% of GDP. That is still a level well above the peak of the dot.com mania. The Fed may need to buckle to the recessionary pulses we see around us, but as George Noble explained at minute 8 in this video, the choices in fixed income are as difficult as in equities. Why Is Tesla Worth So Much? Tesla's valuation has been a source of extreme controversy. For the Teslarati and acolytes of Cathie Woods and other forecasters like her, there seems to be no price too high. In KCR's view, Tesla's valuation is indefensible and sets investors up for potentially sharp losses. Right now, investors are being regaled with fantastic stories about the companies yet-to-be built businesses around driverless taxis and, incredibly, insurance sales. With valuations still above dot.com levels and over 20% of the S&P 500 Index weight in stocks priced at a level with little if any precedent for generating durable returns, we believe this matters. A lot. For the purposes of the table above we did use the latter method. Specifically, we took all the stocks with a sales to price ratio of 0.10 or less, calculated a value-weighted average and then using the reciprocal to get the 13x you see above. Were we to use a method of value weighting P/S multiples, the value would have been 14x. Tesla Valuation vs. Other Car Companies One of the things that we find to be a simple truth is that Tesla is a car company. With that in mind, we find it nothing short of stunning that the firm is valued at nearly 4x that of Toyota. As the world's largest, most profitable car maker, Toyota has also built and sold over 15 million hybrid vehicles with bullet-proof reputations for quality. For similar context, Tesla is valued at over 11x that of Volkswagen. VW is the world's largest car maker and owner of premium brands like Porsche. The company has launched a barrage of brand new vehicles designed to take the EV crown from Tesla in short order. One of the fund managers on KCR's Equity Research team covered auto stocks for years and believes investors are underestimating the tremendous competitions coming out of Ford, GM, VW, Kia and others. Our team would also note that Toyota continues to quietly make progress on a solid state lithium ion battery. Toyota's engineering prowess is not to be underestimated and, assuming they close the production gap, it will instantly render the vast factories recently build by Mr. Musk obsolete. As one industry observer put it "Tesla is like Microsoft, except instead of focusing on the software, they went all-in on building factories to manufacture 5.25 inch floppy disks." We cannot help but agree. YOU ARE NOW READING BASIC MEMBER LEVEL CONTENT The Dot.com Precedent & The Fate of 10x Price to Sales vs The Rest The chart below is simple. https://kailashconcepts.com/wp-content/uploads/2021/11/icons8-vertical-line-50.pnghttps://kailashconcepts.com/wp-content/uploads/2021/11/icons8-lock-50.pngSubscribe now to unlock the full content 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YOU ARE NOW READING BASIC MEMBER LEVEL CONTENT The Dot.com Precedent & The Fate of 10x Price to Sales vs The Rest The chart below is simple. It shows the returns from the dot.com peak to its trough in 2002 for the following: First bar: the losses suffered by the stocks over 10x price to sales were an incredible -73% Reminder: a -73% decline requires a 370% increase to break even Second bar: the S&P 500 index’s drawdown was a far-more-modest -38% Third bar: the stocks in the index valued below 10x price to sales fell only -26% This is not complicated. An S&P 500 tracking index fund exposes nearly 20% of your money to stocks valued at over 10x price to sales. This has never ended well. We doubt it will this time either. Is this where you want your retirement? These findings are consistent with our 2019 piece IPOs, Index Inclusions & the Passive Patsies which documented how index funds have a history of absorbing overpriced IPOs at moments of market euphoria. In December of 2020 we put out a glib but no-less important warning Are Index Funds High Risk Products? That little video highlighted how index fund investors were being stuffed with a concentrated portfolio of mega-cap stocks that had undergone a period of unsustainable multiple expansion. If you are wondering “why would I want to have so much money invested in stocks priced without a precedent for generating decent long-run returns?” you have our sympathies. But let us explain why. You are a human being. If the world engages in another round of speculative buying, those high-priced stocks will run higher. Without any exposure to them you will feel like you are missing out. We do not say this in a sarcastic or condescending way. Discipline is nearly impossible to maintain. We advocate for anything that helps. The Evidence in Favor of Cheap Beta: Hedging “FOMO” or the Fear Of Missing Out While that might sound trite in this moment of market drawdowns, we would remind you that the largest inflows to equity markets occurred in 2021. As shown in our second chart above, 2021 was a year where valuations were well above the Dot.com peak. MarketWatch produced a staggering chart from BofA showing that flows were north of $1 trillion in 2021. A level greater than the “...cumulative inflow of the last 20 years.” We have reproduced it below. You can see that we were net sellers of stocks in 2008 and 2009. In 2008 and 2009, the market was as at generational lows. Those were the precise moments that Warren Buffett very kindly explained to us why he was investing in a public Op-Ed. While he sat on record cash in 2021, the investing public piled in. The cycle repeats. Keep some money in cheap beta if only to avoid exacerbating future emotionally driven decisions. The table below shows the fundamentals of three groups of stocks. Row 1: stocks in the S&P valued above 10x sales, trade at 41x earnings and have high betas (1.2) Row 2: the S&P 500, excluding the stocks over 10x sales provides investors with a cheaper portfolio Row 3: that is our firm’s actively managed, rules-based portfolio, that we believe will, over time, significantly outperform the S&P 500 The contrast between the three portfolios is stark. Despite being valued at a significant discount to the market, the KCR portfolio features high quality stocks with 48% ROEs which pay a total yield of 7.5%. Pay less and get more. This is not complicated. KCR asks the well-intentioned advocates of using only index funds, like Larry Swedroe, to contemplate what we believe are some pretty serious issues with index funds today. This quick missive, like our piece on the Vanguard Small Cap Index Fund, uses a simple single common-sense item to show that index funds have never looked more dangerous. To be specific: Do you really want half your client’s small-cap money in stocks that lose money despite the overwhelming evidence that these stocks generate terrible returns? Do you really want 20% of your clients’ money invested in large cap index funds that are so concentrated they fail the SEC’s own diversification rule for Active Managers? Aside from the concentration issue, why would you want 20% of client’s money in stocks over 10x price to sales when history tells us, no good comes of stocks at those valuations? These are serious questions for a group of products that have never been more popular and widely adopted than they are today. As we explained in our prior piece, taken too far even the best intentions backfire. We are not here to convert the index faithful. That group has adopted a level of intellectual zealotry and conformity that we simply do not adhere to. We believe passive products are an incredibly important part of a well-diversified portfolio. We find the Tesla PS ratio, and other stocks at similar valuations, to create needless and easily avoidable risks for investors. But for the patient investor looking for some margin of safety, working with a low-cost, tax efficient and highly disciplined active manager strikes us as equally, if not more important, than any time in history. Please keep on the lookout for our upcoming work which will explain what we believe is a serious statistical error in the methods of analysis used by the index-only fanatics. YOU ARE NOW READING PREMIUM MEMBER LEVEL CONTENT PHN2ZyB3aWR0aD0iMzIiIGhlaWdodD0iMzIiIGZpbGw9Im5vbmUiIHhtbG5zPSJodHRwOi8vd3d3LnczLm9yZy8yMDAwL3N2ZyI+PHBhdGggY2xhc3M9InNpbmdsZV9fcGRmLWljb24tc3Ryb2tlIiBkPSJNMjAgMXY4aDgiIHN0cm9rZT0idmFyKC0tZzYpIiBzdHJva2Utd2lkdGg9IjIiIHN0cm9rZS1taXRlcmxpbWl0PSIxMCI+PC9wYXRoPjxwYXRoIGNsYXNzPSJzaW5nbGVfX3BkZi1pY29uLXN0cm9rZSIgZD0iTTI4IDEzVjlsLTgtOEg0djEyTTQgMjd2NGgyNHYtNCIgc3Ryb2tlPSJ2YXIoLS1nNikiIHN0cm9rZS13aWR0aD0iMiIgc3Ryb2tlLW1pdGVybGltaXQ9IjEwIiBzdHJva2UtbGluZWNhcD0ic3F1YXJlIj48L3BhdGg+PHBhdGggY2xhc3M9InNpbmdsZV9fcGRmLWljb24tZmlsbCIgZD0iTTEzLjE0MyAxOS4xMDVjMCAuNjM4LS4xODggMS4xMzEtLjU2NCAxLjQ3OS0uMzc2LjM0OC0uOTExLjUyMS0xLjYwNC41MjFoLS40MzRWMjNIOC45OTh2LTUuNzExaDEuOTc3Yy43MjEgMCAxLjI2My4xNTcgMS42MjUuNDczLjM2Mi4zMTYuNTQzLjc2Mi41NDMgMS4zNDN6bS0yLjYwMi43NDNoLjI4MWMuMjMyIDAgLjQxNi0uMDY1LjU1My0uMTk1LjEzNy0uMTMuMjA1LS4zMS4yMDUtLjUzOSAwLS4zODYtLjIxMy0uNTc4LS42NDEtLjU3OGgtLjM5OHYxLjMxMnpNMTguOSAyMC4wMjNjMCAuOTUzLS4yNjIgMS42ODgtLjc4NyAyLjIwMy0uNTI1LjUxNS0xLjI2Mi43NzQtMi4yMTMuNzc0aC0xLjg0OHYtNS43MTFoMS45NzdjLjkxNyAwIDEuNjI1LjIzNCAyLjEyMy43MDMuNDk4LjQ2OS43NDggMS4xNDYuNzQ4IDIuMDMxem0tMS42MDEuMDU1YzAtLjUyMy0uMTA0LS45MTEtLjMxMS0xLjE2NC0uMjA3LS4yNTMtLjUyMS0uMzc5LS45NDMtLjM3OWgtLjQ0OXYzLjE5OWguMzQ0Yy40NjkgMCAuODEyLS4xMzYgMS4wMzEtLjQwOC4yMTktLjI3Mi4zMjgtLjY4OC4zMjgtMS4yNDh6TTIxLjQ0MyAyM2gtMS41MnYtNS43MTFoMy4zNzV2MS4yMzhoLTEuODU1djEuMDloMS43MTF2MS4yMzhoLTEuNzFWMjN6IiBmaWxsPSJ2YXIoLS1nNikiPjwvcGF0aD48cGF0aCBjbGFzcz0ic2luZ2xlX19wZGYtaWNvbi1zdHJva2UiIGQ9Ik0zMSAxM0gxdjE0aDMwVjEzeiIgc3Ryb2tlPSJ2YXIoLS1nNikiIHN0cm9rZS13aWR0aD0iMiIgc3Ryb2tlLW1pdGVybGltaXQ9IjEwIiBzdHJva2UtbGluZWNhcD0ic3F1YXJlIj48L3BhdGg+PC9zdmc+Click here to download the Premium PDF https://kailashconcepts.com/wp-content/uploads/2021/11/icons8-vertical-line-50.pnghttps://kailashconcepts.com/wp-content/uploads/2021/11/icons8-lock-50.pngUpgrade your subscription now to unlock the full content As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade. If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you. KCR also offers a wide range of easy-to-use but sophisticated tools. Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias. L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded. The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra reading for anyone seeking out more information related to the topics above. Speculative Trading MO Altria Stock Inflation Hedge Large Cap Core Fund Best Mean Reversion Strategy Lucid Car Market Neutral Portfolio What Is A Bear Market Bear Market Meaning Difference Between Large Cap and Small Cap Cheap Dividend Stocks Why is the Labor Market Tight? High Dividend Cheap Stocks Gas Mileage of Tesla S&P 500 Calculator The data sheet I was looking at happened to be monthly, numbers are as of April 29, 2022 Enter this into google search: “Kailash Concepts” “10x price to sales” if you want to see our archives on this This observation was made using a value weighting of the top 10 stocks’ calculated Price to Sales ratios. We readily acknowledge that starting with “PS” and multiplying by weights will generate different values than using sales to price ratios, value weighting the collective sales to price ratios and then flipping them to a “P/S ratio.” Using this method, the top 10 stocks had a PS ratio of 4.1x. Disclaimer The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. 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