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1. The Growth Lever: The revenue growth rate controls how much and how quickly the firm will be able to grow its revenues from autos, software, solar panels and anything else that you believe the company will be selling. Rather than focus on the growth rate, I would suggest looking at the estimated revenues in 2030 (ten years out). In my Tesla story (valuation), I have estimated revenues of $125 billion in 2030, a five-fold increase over the 2019 revenues.
2. The Profitability Lever: The target (pre-tax) operating margin determines how profitable you think the company will be, once its growth days start to scale down. Since these are operating margins, not gross or net margins, they are after all operating expenses (cost of goods sold, SG&A etc.) but before any financial expenses (interest expenses). In keeping with my view that R&D is really a capital expense, I capitalize R&D, which improves Tesla’s profitability, and target an operating margin of 12% by 2025.
3. The Investment Efficiency Lever: To grow, companies have to invest in production capacity and the sales to invested capital drives how efficiently investment is done, with higher sales to capital ratios reflecting more efficiency. With Tesla, I assume that every dollar of investment (in new factories, technology and new R&D) in the first 5 years generates $3 in revenues, as it utilizes excess capacity in the early years, and that this efficiency drops back by a third, as capacity constraints hit.
4. The Risk lever: There are two inputs in this valuation that incorporate risk. The first is the cost of capital that I start the valuation with, a reflection of risk as seen through the eyes of a diversified investor in the company. The second is the likelihood of failure (or distress), where the company has to liquidate assets and lose the additional value that it could have generated as a going concern. With Tesla, I set this cost of capital at 7% and assume that given its marginal profitability and significant debt load, the chance of failure is 10%.
