Electric vehicles are on the rise, says just about everybody in the world right now. Climate change is accelerating at a rapid pace, governments are pushing electric subsidies and incentives, and more and more people are going electric.
But how is this affecting stock prices in the US, and how do valuations compare to legacy carmakers? The answer is nuanced (like most things in markets).
Is the EV market growing?
Despite the seemingly ubiquitous hype, EV sales are only just starting to make inroads (pun absolutely intended) into the US market. Of all new light vehicles registered in 2022, only 4.3% were all-electric.
However, the trajectory is notable. The figure was 3% in 2021. And looking at January of 2023, 7.1% of the 1.2 million new light vehicles registered were all-electric.
While the growth is likely partially due to the increased understanding of the threat of climate change, there is also the pragmatic factor of the Biden administration’s Inflation Reduction Act of 2022 (IRA), undoubtedly the most significant climate legislation in US history.
Transportation is a big source of emissions, and EVs are seen as the way to reduce a lot of this. The IRA is packed full of EV incentives and subsidies. Among the most impactful is the return of the $7,500 federal EV tax incentive, eligible for 30 different models, but Biden’s reign has been a boon for the industry as a whole.
EV companies trade like tech stocks
While all this is good news, the numbers here are still low. Claiming 4.3% of new car sales is a tiny slice, meaning profits are not exactly easy to find when assessing EV stocks.
Instead of earnings, investors are clinging to growing revenue in the hope that profit will come further down the line. If this all sounds eerily familiar, it should: this is how one typically describes a tech stock.
Make no mistake, EV companies are trading like tech stocks, rather than your traditional automaker. Of course, there is an elephant in the room: interest rates.
Until last year, tech stocks have performed stupendously since the Great Financial Crash. I wrote a data dive into the performance of different countries’ stock indexes last week, pointing towards the meteoric growth of the tech-heavy Nasdaq as a prime reason behind the surge in US stocks over the last decade.
With interest rates generationally low, i.e. near zero, for much of the decade, high-risk assets went bananas, with tech stocks leading the show. The Nasdaq sprinted clear of the field, multiplying a staggering 12.7X from its 2009 low to its 2021 peak.
Interest rate hikes crush EV companies
But with an inflation crisis gripping the US, the Federal Reserve had no choice but to enter one of the quickest rate hiking cycles in recent memory. With T-bills now yielding 5%, liquidity has been sucked out of the system, and tech stocks were crushed last year.
This, of course, extends to EV stocks, which are risky even among this risky tech sector. Tesla, the unquestioned market leader, lost two-thirds of its market cap in 2022, performing significantly worse than the Nasdaq, which shed one-third.
The extreme volatility of Tesla highlights how sensitive the sector is. While on the one hand, you could argue that Tesla became symbolic of the Robin Hood pandemic-fuelled stock hysteria – it was frequently the stock with the highest volume traded throughout COVID – the fact the sector’s largest stock is reverberating so violently sums up the growth nature of the industry.
Because while Tesla draws headlines for its outsized volume (it was also often the most shorted stock throughout the pandemic), the company at least makes a profit, something which almost every competitor in the space doesn’t. Rivals can only look at its $3.62 EPS in 2022 with envious eyes.
Not only that, but it’s market share is outstanding: it scooped 65% of new EV sales in 2022. Even if its dominance is falling – the same figure coming in at 79% in 2020 – that is a stout lead by any stretch.
EV stocks are far out on the risk spectrum
Tesla should give investors an understanding of the risks here. Of course, with risk comes reward, and Tesla is up 50% this year as the tech sector has propelled off the back of softer forecasts around the path of future interest rate rises.
But Tesla is one name. And in the words of controversial CEO Musk, “the goal is not to be a car company”. Not only is Tesla big for the EV space, it’s just flat out big, currently the ninth largest public company in the world by market cap.
But in looking at the rest of the market, EV companies are highly volatile and do not possess large market caps. There are only four other companies north of $10 billion in market cap: LI Auto ($24 billion), Nio ($14 billion), Lucid Motors ($13 billion) and Rivian ($11 billion).
Furthermore, much like how the Internet delivered on all its promise and more, yet for every Amazon there were five failed dot-com companies; investors should require more than simply believing in the future of EVs as an industry to invest in any of these companies.
This is made a more prominent fear by the reality that legacy carmakers such as Ford and GM are moving into the space. These companies will not simply stand by and watch as their old-fashioned gas guzzlers are slowly made redundant.
And they are moving in quicker and quicker. Ford’s Mustang Mach-E model was the third best-selling U.S. EV of 2022, behind two Tesla models, meaning it outsold every model produced by these other EV companies.
It circles back to what is often a naive conclusion for investors: sports gambling will be legalised; therefore I need to buy DraftKings. EV carmakers are going to take over; therefore I should buy Rivian.
Stocks need a growing industry, no doubt. But there is so much more that goes into a stock beyond this. Most notably, there is the concept of being “priced in”. Many of these companies are already trading at outrageous multiples, while profit is almost non-existent across the space. This already tells you that the market is baking in future growth down the road.
This sounds fine, but 2022 should provide investors with food for thought as to how this can go wrong. Interest rates are no longer zero, meaning the allure of future profits is not as salivating as before – cash flows discounted back to the present are significantly smaller at 5% than they are at 0%.
The EV industry will continue to grow. Companies will return dizzying amounts for investors. But companies will also struggle, some won’t make it, and there will be plenty of ups and downs along the way, even for those that do make it. This is a growth industry, a particularly risky subsector of tech, and investors need to bear that in mind when allocating to their portfolio.
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