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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 capital 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 companies issue 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.

Since Tesla has done quite a number of stock offerings and debt issuance in the past, it will have to pay back its shareholders and creditors.

For creditors, Tesla can pay them back by using the operating surplus derived from the efficient use of its assets.

For shareholders, Tesla can reward them in the form of cash dividends or share buybacks when there is a surplus in net profit.

The measure of this operating surplus with respect to the underlying assets or the measure of the net profit with respect to equity produces the return on investment or ROI.

If this return on investment is greater than the costs of capital, notably debt, Tesla’s business will be viable and sustainable in the long run.

Similarly, if the return on investment is greater than the costs of equity, Tesla’s stock price will increase over time.

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 continuously going back to the capital market for more funds in order to sustain the business.

Similarly, if Tesla’s generated rate of return on equity is consistently below the market rate, its stock price will decrease over time.

In this article, we will focus on the return on investment or ROI of Tesla.

But what exactly is the return on investment?

As mentioned, it is the measure of operating surplus with respect to the underlying assets or the measure of net profit with respect to equity.

Specifically, “return on total assets (ROTA)” and “return on equity (ROE)” are exactly the 2 metrics that we need in order to analyze Tesla’s return on investment or ROI.

Let’s take a look!

Return On Total Assets (ROTA)

The return on total asset is arguably the most important measurement in assessing a company’s 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.

In other’s terms, the EBIT is also referred to as the operating income.

It’s the profit after all operating cost and expense is deducted from revenue, but before interest and taxes are accounted for.

As seen from the equation, ROTA relates the operating aspect of the company to total assets.

It is a measure of the 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 a 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 also referred to as the net income or net profit.

Net income is the profit after all operating expenses, interest payments and taxes are accounted for.

Similar to ROTA, ROE is also arguably one of the most important ratios that measure 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's operating income (EBIT)

Tesla’s operating income (EBIT)

* Operating income is a measurement determined in accordance with GAAP and is obtained from Tesla’s income statements.
* TTM figures consists of the sum of the quarterly data on a trailing 12-month or 4-quarter basis.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

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.

For Tesla, its operating income or EBIT had been mostly negative prior to fiscal 2020, illustrating that the company had operated at a loss.

However, Tesla’s operating income has started to turn positive post-1Q 2020 and even rose steadily throughout fiscal 2020.

As of Q1 2021, Tesla’s operating income reached a record high at $2.3 billion on a TTM basis.

In short, Tesla was making money from an operational perspective.

Keep in mind that the operating income has yet to take into account other costs of doing business, including the interest expenses and taxes.

Chart of Tesla Net Income (EAT)

Tesla's net income (EAT)

Tesla’s net income (EAT)

* Net income is a measurement determined in accordance with GAAP and is obtained from Tesla’s income statements.
* TTM figures consists of the sum of the quarterly data on a trailing 12-month or 4-quarter basis.
* Tesla’s fiscal year begins on Jan 1 and ends on Dec 31.

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, let’s take a look at Tesla’s net income for the period from fiscal 2015 to fiscal 2021.

Tesla’s net income is having the same trend as its operating income where negative figures dominated the entire period prior to fiscal 2020.

On average, Tesla incurred a net loss of $1 billion on a TTM basis in each quarter prior to 2020.

However, Tesla’s net income slowly improved post-2020 Q1 and even increased steadily throughout 2020.

As of fiscal 2021 1Q, Tesla’s TTM net income rose beyond $1 billion for the 1st time.

At this level of profit, Tesla was making money and was making tonnes of it at more than $1 billion.

Chart of Tesla Return on Total Assets (ROTA)

Tesla's return on total assets (ROTA)

Tesla’s return on total assets (ROTA)

* Return on total assets is calculated by the author and is based on the ROTA equation discussed previously.
* TTM operating income is used during the calculation of Tesla’s ROTA.

Since we already have the data for Tesla’s operating income, we can proceed to measure the ROTA which is shown in the chart above.

According to the chart, Tesla’s return on total assets had been mainly negative prior to fiscal 2020.

The outcome is expected since the company’s operating income or earnings before interest and tax (EBIT), which was discussed earlier, has been dominated by negative figures prior to fiscal 2020.

Tesla’s negative ROTA means that the company’s asset base did not generate any operating surplus in which Tesla could use to repay creditors.

In this case, Tesla would have probably borrowed more capital or raised more cash from equity to repay creditors.

However, Tesla’s fortune slowly changed starting in fiscal 2020 1Q when its ROTA increased and reached slightly above 4% as of fiscal 2021 1Q.

The positive ROTA indicates that Tesla has successfully derived an operating surplus from its asset base which the company could use to pay creditors.

Since fiscal 2020, Tesla has been having positive ROTA, but it does not necessarily mean that the company’s internal rate of return has exceeded that of the borrowed capital.

At a ROTA of only 4%, Tesla was probably breaking even as its borrowed capital may have cost the company the same rate or even higher.

If the cost of capital was at a higher rate, Tesla’s long-term viability would be in question as the company’s internal rate of return would be insufficient to cover the cost of capital.

Tesla’s ROTA will have to be consistently higher than the 4% going forward in order to sustain the business in the long run.

Chart of Tesla Return on Equity (ROE)

Tesla's return on equity (ROE)

Tesla’s return on equity (ROE)

* Return on equity is calculated by the author and is based on the ROE equation discussed previously.
* TTM net income or net profit is used during the calculation of Tesla’s ROE.

Similar to the ROTA chart, Tesla’s ROE has also been dominated by negative figures prior to fiscal 2020.

At a negative rate of return, Tesla had been unable to derive a surplus from its net profit to reward shareholders.

If Tesla’s negative rate of return had consistently persisted, its share price would have got a hit.

Fortunately, Tesla has managed to reverse all that post-fiscal 2020 Q1, as reflected by the increasing positive return on equity.

As of fiscal 2021 1Q, Tesla has managed to achieve an ROE of nearly 5%, suggesting that the company has been able to derive a significant surplus of net profit.

At an ROE of only 5%, Tesla’s rate of return may not necessarily greater than the rate of return demanded by shareholders.

If the rate of return demanded by shareholders is 10%, Tesla’s stock price will be in a decreasing trend over time.

Tesla will have to consistently achieve a higher ROE going forward in order to sustain an increasing stock price.

In general, the ROE ratio reflects the rate of return to shareholders.

A strong ROE brings success to the company and results in a 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.

The cycle will subsequently lead to higher share prices and bring 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 by the measure of operating surplus with respect to the underlying assets or the surplus from net profit with respect to the equity that produces it.

The 2 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’s ROTA reaches 4% as of fiscal 2021 Q1 while ROE reaches 5% in the same period.

Tesla will have to achieve a higher ROTA in order to sustain the business.

Similarly, Tesla’s ROE of 5% may be too low and will have to consistently achieve a higher ROE to sustain the stock prices.

References and Credits

1. All financial figures in this article above were obtained and referenced from Tesla’s SEC filings which can be found in Tesla Investor Relations.

2. Featured images are used under Cretive Common Licenses and are obtained from Steve Jurvetson.

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{ 4 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.

    • Chris August 29, 2020, 12:09 am

      Yes, “life support” is certainly a good way of explaining it.

      Similar to the term “outpatient care” that was used by another author to describe parents paying for their adult children’s financial obligations year in and year out with no end in sight.

  • Chris August 29, 2020, 12:05 am

    So, in summary…based upon financial facts…it appears that the stock price has a good percentage of “irrational exuberance” embedded within.

    Although I wish all the best to Tesla, it’s interesting to note that any mainstream company that dared to put up such a long string of red numbers would see their stock price get hammered immediately with calls for some or all of the C-suite to resign.

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