How Big of a Problem Is Tesla's Shrinking Gross Margin?
Electric vehicle maker Tesla (NASDAQ: TSLA) has been reducing its prices to help stimulate more revenue growth. And the move has paid off, with the company posting a strong second-quarter earnings report on July 19 that saw its sales climb nearly 50% year over year. The problem, however, is that with lower prices, the company's margins have been shrinking. Below, I'll look at how much they have shrunk recently and how serious a problem this poses for Tesla's shareholders.
Gross margin has fallen below 20%
For the second quarter, gross profit of $4.5 billion was just 18% of total revenue ($24.9 billion). Although the top line showed strong year-over-year growth of 47%, gross profit increased just 7% for the period.
Data by YCharts.
The good news for investors is that with operating expenses kept under control, the company was still able to report a strong net profit of $2.7 billion (10.8% of revenue), and it was up 20% year over year. On the other hand, for all that revenue growth, one could argue Tesla's bottom line should have been much stronger. A year ago, the carmaker's net margin was 250 basis points higher at 13.3%.
If profits don't increase, the valuation will only get worse
A big knock on Tesla stock over the years has been its often excessive valuation. And at 76 times earnings as of this writing, that's still the case; investors are paying a massive premium for the stock. Although it's not at the levels seen a year ago, it's still not a cheap stock by any means:
Data by YCharts.
For Tesla to be able to continue justifying such a high premium, investors need to believe that the business will grow its bottom line. But with earnings growth straggling the company's soaring top line, that could be a problem. Expecting this level of revenue growth long term just isn't realistic; eventually, the growth rate will slow down.
Even though analysts have been boosting price targets for the stock recently, the consensus price target is only $227 and implies a downside risk of 15% for Tesla from where it trades right now.
Should you avoid Tesla stock?
Tesla is a volatile stock to own, rising more than 110% year to date after falling a whopping 65% in 2022. Given the lingering uncertainty in the economy, and with the company facing the prospect of shrinking margins and potentially tighter consumer spending if a recession hits this year, there are more reasons to be bearish on the stock right now than there are to bullish, especially in light of Tesla's high valuation.
I would suggest holding off on buying the growth stock for now and instead monitoring how its profitability holds up in future quarters. With electric vehicle competition only increasing, it could be a tough road ahead for Tesla.
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David Jagielski has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Tesla. The Motley Fool has a disclosure policy.
