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2 Easy Ways To Measure Tesla Return On Investment

Tesla Model 3 which are ready for delivery. Source: Flickr

The life or death of Tesla (NASDAQ: TSLA) depends entirely on the rate of return generated by its business. If the generated rate of return is greater than the cost of borrowed capitals or owners’ funds, then the business will be viable. Otherwise, Tesla would have no long-term future. In this sense, the business would not be sustainable in the long run.

The rate of return mentioned is also called “return on investment”. It’s the single most important concept in accessing the viability of a business.

To further illustrate, the investment of a business usually refers to the assets acquired by the business. In general, a business acquired assets by using funds drawn from the financial markets and they are usually in the forms of stockholders’ equity and/or borrowed capitals.

Stockholders’ equity is the owners’ fund and is contributed by business owners such as investors who buy Tesla’s stocks. On the other hand, borrowed capitals are basically loans or debts such as bonds that a business issues to the capital market to raise cash.

Whichever way the business chooses to raise funds to acquire the assets, there is a price to pay. The price to be paid here would be the interest rate of the loans or the rate of return of equity demanded by stockholders.

In the case of Tesla, it has to pay back its shareholders and capital issuers since the company has done quite a numbers of stocks offerings as well as bonds issuance in the past. For Tesla, the payment should only come from its operating surplus derived from the efficient use of its assets.

The measure of this operating surplus with respect to its underlying assets produces return on investment or ROI. If this return on investment is greater than the costs of capitals, notably debts and equity, Tesla’s business will be viable and sustainable in the long run.

On the other hand, if the long-term rate of return of the business is consistently less than the market rate, the business will not survive for long. In this aspect, Tesla will be continuously going back to the capital market for more funds in order to sustain the business.

In this article, we will focus on the return on investment or ROI of Tesla. But what exactly is the return on investment that we will analyze here? As discussed in prior paragraphs, it is the measure of operating surplus or profit with respect to the underlying assets that generates them.

Specifically, “return on total assets (ROTA)” and “return on equity (ROE)” are exactly the 2 measurements that we need in order to analyze Tesla’s return on investment or ROI based on the company’s internal rate of return produced from its operation.

Return On Total Assets (ROTA)

The return on total asset is arguably the most important measurement in assessing a company ROI. It can be derived from the equation below:

ROTA = (EBIT / Total Assets ) X 100%

From the equation above, EBIT stands for earnings before interest and taxes. It’s the profit remained after all operating cost and expense is deducted from revenue, but before interest and taxes are accounted for. In other words, EBIT is equivalent to operating income which can easily be obtained from the income statement or profit and loss account statement.

As seen from the equation, ROTA relates the operating aspect of the company to total assets. It is a measure of operating efficiency of the company. In general, there are 3 main operating variables the ROTA equation is assessing, namely total revenue, total expenses and total assets.

From analyzing the 3 main operating variables, ROTA provides a comprehensive analysis of management efficiency in managing the company assets to generate the required operating surplus. Of course, a higher ROTA ratio reflects better management efficiency in utilizing all the assets.

Return On Equity (ROE)

While ROTA measures the operating efficiency, return on equity (ROE) looks at how that operating efficiency is translated into benefits to stockholders. ROE can be derived from the equation below:

ROE = (EAT / Stockholders’ Equity ) X 100%

From the equation, EAT stands for earnings after tax. It’s the profit after all operating expenses, interest payments and taxes are accounted for. EAT is basically equivalent to net income which can easily be obtained from the income statement or the statement of profit and loss account.

Similar to ROTA, ROE is also arguably one of the most important ratios that measures the efficiency of a business in driving values for shareholders. The higher the ratio, the better the return to shareholders.

You may notice that ROE is a ratio that is largely driven by ROTA. Without a good ROTA, a company finds it almost impossible to generate a satisfactory ROE.

Chart of Tesla’s Operating Income (EBIT)

Tesla operating income

Tesla operating income (EBIT)

The operating income or earnings before interest and tax (EBIT) is one of the required variables in the measurement of ROTA as discussed in the above equation. As such, I have created the current chart to track Tesla’s quarterly EBIT over the previous 5 years from 2015 to 2020.

As the chart shows, Tesla’s operating income or EBIT has mostly been in the negative region in most quarters. There are only a handful of quarters showing positive EBIT. The negative EBIT implies that Tesla has operated at a loss. In this case, Tesla’s earned revenues has failed to cover the respective operating costs, resulting in constant losses as seen from all the negative EBIT in the chart above.

Despite consistent operating losses, Tesla has successfully generated a positive operating income of more than $250 million in 3 consecutive quarters from 3Q 2019 to 1Q 2020. On a long-term basis, Tesla’s operating income seems to be improving between 2019 and 2020.

After losing more than $500 million in the 1st quarter of 2019, the loss narrowed down to less than $200 million in 2Q 2019. In 3Q 2019, Tesla managed to make an operating surplus of $261 million and the profitability continues all the way to 1Q 2020 when the company successfully produced another positive operating surplus of $283 million.

Chart of Tesla Net Income (EAT)

Tesla net income

Tesla net income (EBIT)

Similar to operating income, the net income or earnings after tax (EAT) is one of the required components in the calculation of return on equity (ROE). Therefore, the chart above is created to track Tesla’s quarterly EAT for the past 5 years from 2015 to 2020.

Tesla’s net income plot is having the same trend as operating income where negative figures were reported in most quarters. Accordingly, only 6 quarters are seen having positive net income.

Similarly, Tesla’s net income improved tremendously between 2019 and 2020 after suffering massive loss of more than $700 million in 1Q 2019. As seen from the chart, Tesla successfully produced 3 consecutive quarters of positive net income from 3Q19 to 1Q20, generating $143 million, $105 million and $16 million of net incomes respectively.

Chart of Tesla Return on Total Assets (ROTA)

Since the data for EBIT and EAT are already available, we can proceed to creating the ROTA and ROE chart and subsequently analyzing Tesla’s return on investment based on these two ratios.

Tesla return on assets

Tesla return on assets (ROTA)

The chart above shows Tesla quarterly ROTA over a period of 5 years from 2015 to 2020.

As seen in the chart, Tesla’s return on total asset has been negative in most quarterly results. The outcome is expected since the company’s operating income or earnings before interest and tax (EBIT), which was discussed earlier, has also been negative in most quarters.

For quarterly results that show positive ROTA, the returns are way too low and they are generally less than 2% based on the chart. On a yearly basis, Tesla’s ROTA was -0.5% in 2019 and -1.6% in 2018, illustrating that Tesla had operated at a loss in both years.

On a quarterly basis, Tesla managed to produced some positive figures between 2019 and 2020. However, these returns had been less than 1%, indicating that Tesla was operating with considerable amount of such assets as machinery, plants, offices, factories, warehouses, etc.

In 1Q 2020, Tesla produced a ROTA of only 0.8%, meaning that the company generated an operating profit of less than $0.01 over $1.00 of asset.

The company used these assets to generate an operating surplus but the rates of return were just too low considering the amount of assets that the company owned.

In reality, Tesla ROTA of 1% on a quarterly basis or 4% on a yearly basis, is way lower than the required rate of return demanded by the company’s debt holders. In 2019, Tesla paid about $685 million of interest expense on $13.4 billion of debts in the balance sheets. The required rate of return on a yearly basis was in the ballpark of 5.1% using the 2019 data.

Tesla interest expense in 2019

Tesla interest expense in 2019

The snapshot above shows Tesla’s interest expense of $685 million in 2019.

In other words, Tesla borrowed at a much higher rate than the business could produce. In the long term, if the rate of return generated by the business continues at this figure, Tesla business will not be sustainable.

This concept is akin to the situation where you buy an investment property with a loan at 5% interest rate but the rate of return of the property is less than 5%.

Chart of Tesla Return on Equity (ROE)

Tesla return on equity

Tesla return on equity (ROE)

The chart above shows Tesla quarterly return on equity (ROE) over a period of 5 years from 2015 to 2020.

Similar to the ROTA chart, Tesla’s ROE has also been negative in most quarters. There are only 6 out of 21 quarters with positive ROE. As briefly mentioned above, ROE is mainly driven by ROTA. Therefore, without a good ROTA, Tesla’s ROE will almost certainly be worse off.

For example, in quarters that show negative ROTA such as in 2017 and 2018, Tesla ROE dropped to the lowest value at more than -10% and had reached close to -15% in Q2 2018 even though ROTA was only -2% during the same period.

On the other hand, Tesla managed to produce a positive ROE close to 5% in Q3 and Q4 2018 and a small ROE at about 2% in Q3 2019. As of 1Q 2020, Tesla’s return on equity was only 0.1% due to the $16 million of net income produced.

Consistent with the improving net income or earning after tax (EAT) in 2019, Tesla’s ROE was seen improving between 2019 and 2020 when the ratio reversed from a negative value of -11.6% in Q1 2019 to a positive value of 1.9% in Q3 2019. Tesla managed to produced 3 consecutive quarters of positive ROE between 2019 and 2020.

Since Tesla ROE has been mostly negative prior to 2019, the return to shareholders has also been impacted during the same period as seen from its slumping stock price prior to 2019 which at one time plummeted to as low as $150. In these periods, the business brought zero value or even resulted in a loss to equity holders when the company consistently produced negative ROEs.

Turnaround occurred in 2019 when Tesla’s ROE improved consecutively in several quarters throughout 2019 and 2020, driving values to stockholders as seen in the positive ROEs, albeit minimally at less than 5%. The positive ROE has driven Tesla’s stock price to new high as of 1Q 2020 to more than $900 as investors were pleased with the results.

In general, the ROE ratio reflects the rate of return to shareholders. A strong ROE brings success to the company and results in higher share price. Furthermore, a good ROE enables a company to have easier access to new funds – almost certainly at a lower rate – to enable the company to grow even further and generate greater profits given a suitable market condition.

All this will subsequently lead to higher share price and greater wealth to stockholders.

Conclusion

In summary, Tesla return on investment or ROI can be analyzed by looking at the internal rate of return generated by the business. The internal rate of return can be derived from measuring the operating surplus with respect to the underlying assets that produces it.

Two most commonly used approaches to measuring the rate of return of a business are Return on Total Assets (ROTA) and Return on Equity (ROE). ROTA measures the operating efficiency of a business while ROE looks at how that operating efficiency is translated into profits to its shareholders.

Tesla ROTA has been in the negative from 2015 to 2020 and only 6 out of 21 quarters show positive ROTA over the 5-year period. Tesla’s estimated ROTA of 4% in 2020 on an annual basis was lower than the interest rate demanded by debt holders which was around 5% in 2019.

Similar to ROTA, Tesla ROE has also been in the red in most quarters and recorded positive rates of return in only 6 quarters. However, the improving ROE in 2019 and 2020 to positive values drove investors to euphoria which has resulted in record stock price of more than $900 in 1Q 2020.

References and Credits

1. Financial figures in all charts above were obtained from financial statements available in Tesla Website.

2. Featured images were obtained from Steve Jurvetson.

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{ 2 comments… add one }
  • Alan January 14, 2020, 3:09 pm

    Great summary of ratio analysis, plus I seem to agree with the conclusion you come up with.
    Also read your post of stock dilution over the years which match your statement of tesla being on “life support”. Makes me wonder which tools and valuation models wall street analysts are using to justify such high price targets with little explicit positive fundamentals to rely on.

    • cckean January 14, 2020, 8:52 pm

      Thanks for the feedback. I would love to hear what readers have to say. Please do not hesitate to pinpoint and criticize if you found any mistake or discrepancy in the article.

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