Home > Uncategorized > Tesla, Amazon, and Bitcoin

Tesla, Amazon, and Bitcoin

from Dean Baker

The soaring price of Bitcoin is a useful lesson about markets for people who seem to very quickly forget the last lesson. Bitcoin, a digital algorithm, backed by absolutely nothing, has been selling for more than $16,000.

Perhaps Bitcoin’s price will double or triple again. After all, who knows how badly people need digital currencies that are not really currencies? But more likely the market will run out of people who are willing to trade real money for nothing. At that point Bitcoin’s price will plunge and may approach its underlying value of zero.

In the meantime the price surge shows us that markets are capable of enormous amounts of irrationality. This is helpful for people who can’t remember the stock bubble at the end of the 1990s. Favored stocks, like AOL, often reached price to earnings ratios in the stratosphere, if they even had earnings. In AOL’s case, its market valuation topped out at more than $220 billion in December of 1999. When it was sold to Verizon sixteen years later the company was worth just over $4 billion. Many other high flyers of the bubble years, like Webvan and Pets.com, simply went out of business.

For those who consider 1999 and 2000 the distant past, we need only go back to 2006 and 2007 when subprime mortgage backed securities (MBS) all got top investment grade ratings from the bond rating agencies. These MBS were worth just a small fraction of their face value a couple of years later after the housing bubble burst. Nonetheless, “informed” investors placed trillions of dollars in MBS assuming them to be almost as safe as U.S. government bonds. 

But even this may be too far in the past for many of today’s market whizzes. For this reason we should all be thankful that we have Bitcoin to remind everyone that just because lots of money sits behind a product or company, it doesn’t mean the valuation makes sense.

While I don’t think we again have a bubble in the stock or housing market, there are certain stock and housing markets where irrational exuberance seems to be determining prices. To take two of my favorites in the stock market, this certainly seems the case with Tesla and Amazon.

Based on its end of year market price, Tesla had a market capitalization of $52.3 billion. (Its value had been over $60 billion earlier in the fall, so perhaps some re‐evaluations by shareholders are already taking place.) By comparison, GM had a market capitalization of $58.2 billion and Ford had a market cap of $49.6 billion.

Over the prior year GM earned over $6.5 billion in after‐tax profits. Ford earned almost $4.5 billion. By contrast Tesla lost over $600 million in the third quarter of 2017 after losing $300 million in each of the prior two quarters.

Stock prices are of course forward looking, not focused on the past. Tesla investors are presumably betting that Tesla will turn around and stop making losses and rather at some future date have considerably larger profits than either of its two major U.S. competitors. The question is why would anyone believe this, and perhaps more importantly, why would anyone believe this turnaround would happen any time soon?

The idea is that Tesla will be a leader in electric cars, and that as electric cars displace gas fueled vehicles, Tesla will dominate the market. Of course anything, but GM and Ford also produce electric cars, and these companies have much better records of meeting production deadlines with their products.

Perhaps more importantly, foreign car manufacturers are also producing electric cars, especially in China. China is on a path to sell close to 160,000 electric cars in the fourth quarter of 2017, more than three times the volume in the United States.

It surely is only a matter of time until they look to export these cars to the United States. Perhaps Tesla’s president, Elon Musk will become a world class protectionist and insist the Chinese cars be kept out to protect his profits. But if that doesn’t happen, it is difficult to see how the company’s stock price could ever make any sense.

Amazon’s stock price is perhaps even more out of line. Its market capitalization based on end of its yearend price was $563.5 billion. This compares to after‐tax profits of $1.9 billion. Investors seem happy with Amazon because it sales continue to rise rapidly. But most of these sales come at a loss to the company, without the profits from cloud computing division the company would be showing losses.

But again, the stock price is supposed to be justified by future profits. Let’s imagine what this could look like ten years out at the end of 2027. Suppose Amazon’s stockholders get a 7.0 percent real return over the next decade, a modest assumption given the company currently makes almost no profits and therefore should be viewed as highly risky.

In that case, the market cap would be just over $1.1 trillion, in 2017 dollars. Suppose its sales rise at an average rate of 10 percent annually, after adjusting for inflation. This would put its 2027 sales at just over $360 billion, also in 2017 dollars. If we assume that as a relatively mature company (Amazon will be 30 years old at that point) it should have a price to earnings ratio of 20 to 1, this implies profits of $55 billion.

To generate $55 billion in profits on $360 billion in sales, Amazon would have to mark up its prices by 15 percent over current levels. (This is after adjusting for inflation.) Perhaps Amazon could still keep its market share if it raised prices by 15 percent, but that seems a rather heroic assumption. Who knows, maybe Bitcoin will have gone to $1 million by then.

Anyhow, there are plenty of investors with lots of money to throw around. They often have no clue what they are doing as we are continually reminded by crashes in various markets. The case of Bitcoin is perhaps just a bit more obvious than most.

See article on original site

  1. Rob Reno
    January 9, 2018 at 4:37 am

    Didn’t some smart guy do a PBS show called Mind Over Money that showed that markets are sometimes very irrational?

  2. January 9, 2018 at 7:22 am

    Don’t for one second think bitcoin is a bubble, fad or phase. Its here to stay long term, as proven, time and time again. There’s some interesting facts here about it http://bitcoinmiracles.blogspot.com

    • January 9, 2018 at 1:27 pm

      Here’s the problem you’re not paying attention to…

      Why should I buy your bitcoin, that you created out of nothing, when I can create my own cryptocurrency out of nothing (with the help of a blockchain coder)?

      When everyone is able to create their own “money”, what is it ultimately going to be worth?

      The outcome will be similar to everyone being free to print their own dollars/pounds/euros, counterfeit but indistinguishable from ‘the real thing.’ Think about it…

      This whole bitcoin thing was ginned up by some clever people, but there are a lot of other clever people out there, as well.

      Being able to get in on a “tulip” investment bubble at just the right time is fortuitous for the lucky gambler, but not a path to a glorious future for all…

      Maybe you’ll be one of the lucky ones, eh?

      • Rob Reno
        January 9, 2018 at 4:39 pm

        I have made sure my children read your comment James. Much appreciated and totally agree.

      • Ed Seedhouse
        January 10, 2018 at 4:14 pm

        “Don’t for one second think”

        Yep. Bitcoin is for those who don’t think, even for a second…those of us who do, at least occasionally, can see the bubble as plain as a boil on the end of our noses.

    • Drew
      January 11, 2018 at 9:26 am

      The fact that you are pointing to a “book” published 4 years ago that claims “Amazon is also predicted to accept bitcoin in 2014” is a pretty good rebuttal to your analysis.

    • January 11, 2018 at 2:55 pm

      Any given currency has value to the extent that other people are willing to sell you goods and services for it. So far, people are only willing to take bitcoin as payment for zero-marginal-cost digital content. That is likely to continue.

  3. Rob Reno
    January 9, 2018 at 4:42 pm

    Famous First Bubbles: The Fundamentals of Early Manias
    by Peter M. Garber
    Link: http://a.co/9I70pGS

    Boom & Bust: A Look at Economic Bubbles
    by Fredrick Kennard et al.
    Link: http://a.co/5rPkJgP

  4. January 9, 2018 at 6:20 pm

    Agree with what you are saying about bitcoin, although I suspect you don’t understand the implications of blockchain.

    Regarding Amazon and Tesla, the case is not so clear-cut. Tesla is, by all accounts, a magnificent car, (highest ever review on consumer reports) and if Musk can exploit economies of scale, the cost of Tesla’s will eventually fall sharply. GM and Ford are classic examples of the kind of companies that Clayton Christensen talked about in innovators dilemma. If you believe the future of cars is electric and autonomous, which I do, then I have far more faith in Tesla than I do Ford and GM. Tesla is in a race, can it maintain investor confidence long enough for it to reach scale?

    As for Amazon, the issue you don’t get is AI. I would say that of all the major retailers in the world, Amazon is the most likely to survive the technological revolution that is underway.

    I know about bubbles and madness of crowds, but the question is, if you apply the ironic statement ‘this time it is different’ should you apply it to Amazon and Tesla, or the likes of Ford, GM, and major retailers, when a study of the history of disruption would say these are the companies that look vulnerable. Also, consider the valuation of Google at IPO, similar arguments were made to yours at the time to suggest it was overvalued. Yet its annual profits now suggest the IPO price was dirt cheap.

    PS One more point about Tesla, it is more an energy storage company than it is a car company, it is using the cars as a way to gain scale in battery technology, and I would say that battery technology is about to become a world-changing business.

    I am not saying there won’t be a mini technology stock market crash at some point, but forward wind the clock ten years, Amazon will probably be the largest company in the world. and Elon Musk will be much revered.

    • Risk Analyst
      January 10, 2018 at 8:19 pm

      In the same way you point out that Tesla is not so much a car company as it is an energy storage company, Amazon seems to have a footprint in three spaces: retail, tech, and media. In each of those sectors there are competitors and it is not clear that Amazon can win in all three, especially facing down the likes of salesforce.com in tech. If one falls back on Finance 101, a factor in a company’s future is barriers to entry. Ford per your example, has huge barriers while in AI space I can be doing that (not well, but doing it) on my PC by this afternoon. I am not disagreeing with you and would not be surprised if Amazon were the largest in a decade so this is kind of just me thinking out loud. Excellent post by the way.

  5. January 11, 2018 at 1:42 pm

    The bet with the tech companies is that they’ll become “life subscription” brands, providing everything to their audience from communications, computing, and entertainment to physical goods, energy, banking, or transport. It’s a big bet with quite scary implications if it succeeds. The valuation reflects this play for concentrated market power and disruption of existing businesses.

    Of the big four Amazon is closest to realizing that vision and making a profit, largely because they’re not shy to use the old business model of selling things for money. Google and Facebook successfully provide news, information and identity services as public goods but are only really good at monetizing indirectly through ads. Apple is too successful making shiny devices to become a service company.

    Personally I want the public goods that Google et al put out now but I want the investors’ bet on world monopoly to fail. At some point these economic realities will have to be reconciled and it will get ugly.

    For Tesla it’s harder to tell. People expect it to revolutionize the car the way Apple re-invented the phone, but I don’t know that there’s that much scope to do that. If Tesla re-positioned as an energy or personal transport company then maybe. I don’t really want to own a car again.

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