Tesla: What’s The Outlook After Announced 3-For-1 Stock Split? (NASDAQ:TSLA)

Thesis

Tesla’s (NASDAQ:TSLA) business won’t be impacted by a stock split, but the split might increase TSLA stock’s volatility by making options more accessible to retail traders. Regardless, while Tesla is a high uncertainty stock, the current valuation is more or less supported by fundamentals.

The Details

Tesla recently announced plans for a 3-for-1 stock split in an SEC filing. The proposal will be put to a vote at Tesla’s shareholder meeting on August 4th. It will likely pass, so investors can expect the split to take effect some time after August 4th.

Tesla said that one reason for the split was to give employees “more flexibility in managing their equity,” noting that unlike other car companies they give every employee the option to have some equity-based compensation. However, they weren’t specific about how a stock split would give employees more flexibility.

Stock splits don’t impact a stock’s fundamentals, as the increase in shares outstanding offsets the decrease in each share’s price. But splits are often considered an indication that a company is confident in its future prospects, and Tesla performed very well the last time it split its shares in 2020. Apple (AAPL) is another example of a company that performed well during its last stock split. However, companies that have announced or performed splits this year like Amazon (AMZN), Google (GOOG), and Shopify (SHOP) haven’t been saved from the broader market selloff.

Considering the lack of a clear pattern in these examples, trying to time Tesla’s stock price movement based on the split announcement is probably a bad idea, even if there’s some evidence that companies that split their stock often outperform in the short term.

The Retail Factor

Tesla also noted that “as retail investors have expressed a high level of interest in investing in our stock, we believe the Stock Split will also make our common stock more accessible to our retail shareholders.”

It’s no secret that Tesla has been a favorite of many retail investors, especially risk-loving options traders. Adjusting for price, Tesla has well over double the short term options volume of most other mega caps like Microsoft (MSFT). And only 42% of Tesla shares are held by institutions, which is low relative to the other mega cap companies.

The stock split could serve to increase retail interest in Tesla stock options. Unlike regular shares, options can’t be purchased fractionally. Right now, a single $705 call expiring on 7/22 would cost over $5000. That’s expensive for a retail investor, especially one who’s already lost most of his money “yoloing” on such short dated calls. But if each share is split into thirds then the cost is somewhat more reasonable, coming in below $2000. And shorter dated or further out-of-the-money options would be even cheaper.

By making its options more accessible to its retail shareholder base, Tesla could see an even further uptick in options volume. Because options are essentially leveraged, they can have a large impact on the underlying asset’s share price. This increases volatility, and can lead to share price appreciation through mechanics like gamma squeezes. Tesla’s rapid share price appreciation in 2020 was attributed to a gamma squeeze by some well known investors including Michael Burry (in a since-deleted tweet).

That said, lowering the share price through a stock split doesn’t change the fact that Tesla is now one of the largest companies in the world. As Tesla’s market cap continues to increase, the impact that retail investors can have on its price will continue to decrease. So I wouldn’t count on price action like what was seen in 2020 any time soon, regardless of how many times Tesla splits its shares.

The Fundamentals

I last covered Tesla in February, where I rated it a hold. I noted that Tesla’s nearly $1T valuation at the time could be justified by just selling EVs, but that it required optimistic assumptions about future growth and profitability (which I outlined in my last article). However, I noted that because of Tesla’s large impact on the returns of major indexes going forward, investors might want some exposure to Tesla stock in order to more closely track the indexes.

Since my last article, Tesla has fallen 22% while the index has fallen 16%. With shares selling off despite Tesla releasing another solid earnings report, Tesla’s P/E has finally fallen to double digits (95). With a forward P/E of 44 and Elon Musk aiming for growth above 50% for the next couple of years, that puts Tesla’s forward PEG ratio near 1.0. That means Tesla is getting to a point where even GAARP investors might be willing to take a look, although it’s still expensive by many traditional valuation metrics.

Personally, I don’t buy Tesla’s claim that it will maintain 50% growth for years to come. And I remain skeptical of their non-EV businesses like autonomous driving and robotics. Thus, I model Tesla growing at a 25% CAGR this decade, which I think is still optimistic for a company of Tesla’s size. Based on that growth, some operating leverage, and a terminal P/E of 25, I have a $714 price target on Tesla, which is very close to the current price. Thus, I continue to rate Tesla as a hold, although I also recognize that it’s difficult to generate an accurate price target for a high uncertainty stock like Tesla.

Conclusion

Tesla is a very polarizing company, which makes sense considering the wide range of outcomes that are possible in the young EV and autonomous driving industries. The stock split doesn’t change much about Tesla’s story, even if it might get more retail traders interested and lead to increased volatility.

Although Tesla’s returns over the last couple years aren’t likely to repeat from today’s prices, the company still has a path to generate alpha in the coming decade. There’s execution risk and lots of competition, which makes Tesla a high risk stock. But they have a good track record of delivering in difficult environments.