by Jean-Louis Gassée

Two remarkable changes took place in 2019. First, Tesla’s share price reached new heights opening a field of new financing possibilities. Second, Apple stopped trading “like a steel-mill going out of business” ; its shares about doubled last year and it now trades at a P/E ratio that speaks of greater confidence in the company’s future.

Last Friday, after flirting with the $500 level, Tesla shares closed at $478. This is substantially better than the September 2018 “$420 funding secured” tweet that got Musk in serious trouble with the SEC. Musk and Tesla had to pay a $20M fine each and make substantial changes to the company’s Board, such as stripping the CEO of his Chairman title, and more.

The run up of Tesla shares wasn’t universally predicted. To the contrary, a number of investors speculators who had bet heavily against Musk by shorting TSLA got severely burned, to the tune of $1.4B by October and likely considerably more by now. Conversely, Musk made out handsomely from Tesla’s stock rise, profiting more than $10B according to this January 10th, 2020 Fortune article.

More important than the paper fortune that Musk amassed, a high price for Tesla shares puts the company in a favorable position when raising money for future projects, products, and manufacturing plants. We should learn more when Tesla releases its latest quarterly numbers on January 29th.

In the meantime, a comparison gives one pause. At its latest levels, Tesla’s “market cap” — the total value of its shares — reached $90B. This means that the stock market “thinks” Tesla is worth more than Ford and GM combined ($36.7B and $48.8B, respectively; a total of $85.5B). If we use the theory that share prices are an indication of buyers/sellers view of companies’ future, Ford and GM prospects don’t seem overly bright when compared to Tesla.

As much as I admire Musk’s combination of strategic vision and improvisational agility, to say nothing of his ability to advance other initiatives such as SpaceX, one wonders about the meaning of such a market cap comparison. A closer look reveals a striking difference: legacy automakers carry the burden of retirees’ pensions and medical costs. In 2004, for example, there were 2.5 GM retirees per active worker, and in 2009, GM’s pension liabilities were in the $100B range. This let financial writers joke that “GM was in truth a huge pension plan, funded by an automobile operation”. In 2009 GM was bailed out by US tax payers while Ford wasn’t — but the latter carries a similar burden. According to a Barron’s October 2019 article Ford’s pension obligations “is more than 200% of its market value”.

Tesla carries no such burden, it’s still a young company without retirees to support. This, in great part, explains the counterintuitive market cap numbers.

That being said, one can still experience a bit of lightheadedness when contemplating Tesla’s share price. What about the perennially slipping schedules or ridiculous declarations such as the “one million robotaxis” by the end of 2020? ‘All priced in’, say the Tesla bulls, ‘He’s a BS artist, but he’s our artist and, in the end, he executes…’ We’ll know more soon.

Another company’s stock rise also give one’s pause: Apple.

A year ago, on January 2nd 2019, Apple delivered bad news: Its revenue guidance for the quarter just started was reduced by $9B, from $93B “guided” in early November to $84B. As a result, Apple shares plunged to about $152.

One year later, on Friday January10th 2020, Apple closed a little above $310/share and the company’s market cap reached an all-time high of $1.38T (T as in a trillion dollars, one thousand billion). Skipping comparisons to countries’s GDPs, we must ask what caused such a jump in an already large valuation, adding more than $500B to the company’s market cap (the number of shares varied as Apple aggressively repurchased its shared during the year).

An often used measure of market sentiment is the Price/Earning (P/E) ratio of a company. Unfolded, the P/E ratio tells us how many dollars a share (P) a buyer is willing to put on the table to acquire a dollar of earnings (E) for a given company. The higher the P/E, the higher the market’s opinion of the company’s future. For most of its existence, Apple has had a low P/E score, leading Marc Andreessen to observe that Apple traded “like a steel-mill going out of business”. In his January 2018 Apple 3.0 post, Philip Elmer-DeWitt published the following chart that compared the P/E ratio of a few notable companies:

(For reference to steel mills going out of business, GM and Ford P/Es hover around 6…)

In the past year, Apple’s P/E jumped from a low of 12 to a more respectable 26 while, in the same time interval, Microsoft moved from 24 to 32, and Amazon maintained a stable 83. The message from the market is obvious: Even at its lofty $1.3T perch, Apple’s future is less assured than Amazon’s or Microsoft’s. As I noted in an August 2018 Monday Note written when Apple reached a $1T valuation for the first time, we hadn’t found what was “hidden-but-discoverable in the structure of the Apple machine” that explained how it kept defying the low expectations implied by its P/E ratio.

One possible explanation for last year’s remarkable rise comes from Neil Cybart whose Above Avalon notes (behind a paywall) makes substantial, sophisticated reading on Apple and other businesses. Cybart says he can’t attribute the $500B rise in Apple’s 2019 market cap solely to progress in products and services. Instead, he proposes that Apple’s P/E rise is explained by a mechanical effect that occurs when investors move away from active, speculative funds that are constantly trading shares to more passive, Buffett-like vehicles such as index funds:

“Passive investing (index funds) are on the rise as investors are becoming increasingly disenchanted with mutual funds and active funds charging for underperforming the market. As more funds are poured into passive investment vehicles, all of the Wall Street giants (Apple, Microsoft, Amazon, Alphabet) benefit. …While this mechanism doesn’t necessarily lead to Apple’s share of the overall market increasing over time, it can lead to sustained demand for shares regardless of business fundamentals…The most likely explanation for Apple’s run up — however simplistic it may sound — is that active investors have been desperately trying to increase their exposure.”

This is an interesting thought. If I follow the logic, the market is (finally!) becoming comfortable with the notion of a more stable future for Apple. This would indeed be a change. I’ve been part of or closely following Apple since December 1980 and have noted the almost constant skepticism surrounding the company: ‘Yes, Product X, Y, or Z is doing well right now, but it won’t last.’ I’m curious to see how the kommentariat will react to the coming January 28th earnings report and guidance for the following quarter. We’ll see if today’s high valuation is a fluke or a new normal.

— JLG@mondaynote.com