Buy Tesla Stock for a 36% Profit? 3 Things You Need to Know

By Markets Fool.com

Friday's a big day for Tesla shareholders -- but you wouldn't know it from the stock price. This morning, analysts at investment banker Sterne Agee finally published an opinion on Tesla Motors.

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I won't keep you in suspense: They like the stock. Initiating coverage with a buy rating, Sterne Agee predicted that Tesla shares could hit $300 within a year. Calculated from today's opening price of $220, that works out to a potential 36% profit for new buyers.

Surprisingly, Tesla stock has hardly reacted at all to the new rating, however. It's up only 1% so far this morning. Now investors want to know where the other 35% will come from.

Here are three things you need to know to figure that out.


Tesla's Model S -- the car that finally put Tesla stock in the fast lane. Image source: Tesla Motors.

Thing No. 1: Not all the gains will come all at once

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First and foremost, it's important for Tesla stockholders to know that Sterne Agee doesn't predict a straight 45-degree climb for Tesla stock. "Interim swings could trade it from point A down to point B (e.g., stock has shown high correlation to oil prices)," warns Sterne. "But ultimately," the analyst still predicts "a much higher point C" for Tesla stock. A price point of $300, to be precise.

Why is that?

Thing No. 2: But the math still works

Quoting from the write-up on StreetInsider.com this morning, Sterne's report calls Tesla stock "controversial, expensive and risky." But the analyst nonetheless sees a path forward to eventual profits for the stock, and for its investors as well. Here's how Sterne sees it happening.

Start with where we are today: Tesla racked up $4.2 billion in sales over the past year, and $1 billion in losses. That's already a big change from the company that, when we first started covering it, had managed to put just a few hundred electric Roadsters on the road. But Sterne sees even bigger numbers in Tesla's future.

As Sterne calculates it, money from Tesla's 400,000-plus pre-orders for the new $35,000 Tesla Model 3 sedan, plus thousands more sales of higher-priced Model S and X units, should more than double the company's revenue haul to $9 billion this year, and then more than triple it to $32 billion three years from now. By 2018, Sterne sees Tesla selling 500,000 cars annually, and earning more than $10 per share. One year later, profits could soar as high as $17 per share.

Thing No. 3: Valuing future growth

At that point, the math gets really simple. Assume Sterne Agee is right about the $10 per share in 2018 profits. Admittedly, that's a big assumption, but if correct, it means that at today's share price of $220, Tesla stock costs 22 times what it will earn two years from now. Assume the analyst is also right about earnings growing from $10 to $17 per share in 2019 -- that's 70% growth.

Paying a 22 P/E for 70% growth is cheap. Accordingly, Sterne Agee says Tesla is a buy.

Bonus thing: "And one more thing..."

If you think there's any chance at all of Sterne Agee being right about Tesla hitting 500,000 cars sold annually in 2018, and earning $10 a share that year, it almost seems crazy not to buy Tesla stock at today's prices. Fact is, if Tesla hits that benchmark, the company could grow only half as fast as Sterne is predicting in 2019 (i.e., $13.50 per share), slowing the growth rate to 35%, and at 22 times earnings, Tesla stock would still be cheap.

The kicker, of course, is that you have to take it on faith that Sterne is correctly seeing the future, and is right about a stock that currently earns no profits at all (and that according to S&P Global Market Intelligence, never has) suddenly turning wildly profitable two years from now.

That's a remarkably tight turn that Sterne is predicting, even for a superb automaker. Meanwhile, Ford stock is selling for just 6 times earnings that it has already made, and General Motors is selling for less than 5 times trailing earnings.

Granted, neither Ford nor General Motors is as sexy as Tesla stock, and neither of these rivals is projected to grow as fast as the electric-auto pioneer. But both Ford and GM sell for single-digit P/E ratios, boast double-digit projected growth rates, and are earning profits today, rather than just two years from now (and hypothetically, to boot).

In short, if you want to ignore Sterne Agee's advice and buy Ford or GM instead of Tesla, I wouldn't blame you a bit.

The article Buy Tesla Stock for a 36% Profit? 3 Things You Need to Know originally appeared on Fool.com.

Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he's currently ranked No. 310 out of more than 75,000 rated members.The Motley Fool owns shares of and recommendsboth Ford and Tesla Motors. The Motley Fool also recommends General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.