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 that was discussed here is also called “return on investment”. It’s the single most important concept in accessing the viability of a business. When we talk about the investment of a business, we usually refer 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 borrowed capitals. Stockholders’ equity is also called owners’ fund and is contributed by business owners such as investors who have bought Tesla stocks. Borrowed capitals are commonly referred to as loans or debts.
Whichever way the business chooses to acquire its 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.
With all that said, how is Tesla paying back its shareholders and debts issuers? Well, the payment should only come from the 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, Tesla 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 case, Tesla will have to be constantly going back to the financial market for more capitals in order to keep its business running.
In this article, we will focus on the return on investment 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 equity (ROE)” and “return on total assets (ROTA)” are exactly the 2 measurements that we need in order to analyze Tesla return on investment or ROI based on the company’s generated rate of return 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 or expense is deducted from revenue, but before interest and taxes are paid. In other words, EBIT is basically equivalent to operating income which can be easily obtained from the company income statement or profit and loss account statement.
As you can see 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 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 paid for. EAT is basically equivalent to net income which can be easily 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 profits 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 Operating Income (EBIT)
The operating income or earnings before interest and taxes (EBIT) is one of the required variables in the measurement of ROTA as shown in the above equation. As such, I have created the above chart to track Tesla quarterly EBIT for the previous 5 years from 2015 to 2019.
As the chart shows, Tesla operating income or EBIT has been in the negative region in most of the quarters. There are only a handful of positive EBIT. The negative EBIT implies that Tesla has consistently operated at a loss. In this case, Tesla generated revenues have not been able to cover total operating costs, resulting in consistent operating losses as seen from all the negative EBIT in the chart above.
Tesla has successfully generated a positive operating income of more than $200 million in 3Q 2019 after suffering losses in 2 consecutive quarters since 2019. Nevertheless, Tesla operating income seems to be improving in 2019. 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 a profit.
Chart of Tesla Net Income (EAT)
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 quarterly EAT for the past 5 years from 2015 to 2019.
Consistent with the plot of operating income, the net income plot is having the same trend where we are seeing negative EAT in most of the quarters. Only 4 quarters are having positive net income. In other words, Tesla made profits in only 4 out of the 19 quarters shown in the chart.
Similarly, Tesla net income improved tremendously in 2019 from suffering a massive loss of more than $600 million in 1Q 2019 to making a small profit of a little over $100 million in 3Q 2019.
Chart of Tesla Return on Total Assets (ROTA)
Since the data for EBIT and EAT are already available, we can proceed to creating Tesla ROTA and ROE chart and subsequently analyzing Tesla return on investment based on these two ratios.
The chart above shows Tesla quarterly ROTA over a period of 5 years from 2015 to 2019.
As seen in the chart, Tesla return on total asset has been negative in most of the quarters. The result is expected since the company’s operating income or earnings before interest and taxes (EBIT) has also been negative in most of the quarters.
In quarters that show positive ROTA, the returns are way too low and they are generally less than 2% based on the chart. This shows that Tesla is an asset-heavy company where it owns quite a lot of fixed assets such as machinery, lands, offices, factories and warehouses. In return, the company uses these assets to generate an operating surplus but the rates of return are just too low considering the amount of assets that the company owns.
In reality, Tesla ROTA of 2% is way less than the interest rate that the company is paying to debts holders. According to this article, Tesla long and short term debts, Tesla has a total debt obligation of roughly $14 billion (inclusive of leases) by the end of 2018 and the company has incurred about $660 million in interest expenses in 2018 alone based on the 2018 annual statement.
The snapshot above shows Tesla interest expense of as much as $660 million in 2018. By using 2018 interest expense of $660 million and total debt obligation of $14 billion, the average interest rate that Tesla has incurred in 2018 was in the ballpark of 5%.
Assuming that Tesla will incur roughly the same interest rate in 2019, Tesla ROTA of only 2% is much lower than the average interest rate demanded by debts holders which is around 5%. In other words, the company borrows at a much higher rate than the business can 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 similar to the situation where you buy an investment property with a loan at 5% interest rate but the return generated by the property is only at 2%.
Chart of Tesla Return on Equity (ROE)
The chart above shows Tesla quarterly return on equity (ROE) over a period of 5 years from 2015 to 2019.
Similar to the ROTA chart, Tesla ROE has been negative in most quarters. There are only 4 out of 19 quarters with positive ROE. As briefly mentioned above, ROE is mainly driven by ROTA. Therefore, without a good ROTA, Tesla ROE will almost certainly be worst off.
For example, in quarters that show negative ROTA such as in 2017 and 2018, Tesla ROE dropped to the lowest 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 that was close to 5% in Q3 and Q4 2018 and a small ROE at about 2% in Q3 2019. Consistent with the improving earning after tax (EAT) in 2019, Tesla ROE was having the same trend at the start of 2019 when the figure reversed from a negative value of -10% in Q1 2019 to a positive value of 2% in Q3 2019.
Since Tesla ROE has mostly been negative, the return to shareholders has also been impacted during the same period, implying that the business has generated a negative return on investment to its owners. The business has brought zero value or even resulted in a loss to equity holders.
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.
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 values from 2015 to 2019 and only 4 out of 19 quarters show positive ROTA over the 5-year period. Tesla positive ROTA has been less than 2%, indicating that its return on investment based on the total assets are way lower than the interest rate demanded by debt holders which was averagely around 5% in 2018.
Similar to ROTA, Tesla ROE has also been in the red throughout most of the quarters and recorded positive rates of return in only 4 quarters. Tesla’s inability to consistently generate positive ROE shows that the company has not been making profits over the years. This has led to negative retained earnings which is causing a large deficit in the balance sheet. If not for the constant equity issuance over the years, Tesla book value would have been reduced by a large margin.
In short, Tesla has brought negative return on investment to its shareholders over the years. The company has been basically on life support which is pretty much in the form of owners’ funds and debts.
Ironically, the increasing Tesla share price over the 5-year period shows that investors have mostly based their investment thesis not on fundamentals but on hope and expectations.
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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