Here I will present you with information about two mystery companies that operate in the same industry (which is a cyclical one) and are competitors of one another.

Company A Highlights

• Founded in 1908
• $144 billion in trailing 12 month revenue, and consistently $130 billion+ in annual revenue the last decade.
• $21 billion in earnings before interest taxes depreciation and amortization (EBITDA) the past 12 months.
• $8.8 billion in trailing 12 month net income.
• 6.1% net profit margin
• Total liabilities are $182 billion up from $101 billion in 2010.
• Total assets are $231 billion, including $26 billion in cash on hand.

Company B Highlights

• Founded in 2003
• $24 billion in trailing 12 month revenue, which is up from $400 million from 2013.
• $2.24 billion in EBITDA the past 12 months, the first year in its history with any significant positive earnings.
• Negative $800 million in trailing 12 months net income.
• Has never had a positive net income during a calendar year, therefore has never had a positive net profit margin.
• Total liabilities have increased from $450 million in 2010 to $25 billion in 2019.
• Total assets are about $33 billion, including $5.57 billion in cash on hand.

Now given this simple, broad overlook at some key measures. Which company do you think is worth more? It may surprise you to know that Company A currently has a market value of $47 Billion, but Company B currently has a market value of $116 billion.

Company A is General Motors, and Company B is Tesla. Some of you may have already known that. Tesla is currently valued about $35 billion more than Ford and General Motors COMBINED. Charts are not needed in this post, all you need to know is that from 2011 – 2019, Tesla’s stock has compounded at 35.80% annually while GM grew at 2.68%.

You might argue that everybody may drive a Tesla one day, have a Tesla battery storing energy in their home, or have Tesla solar shingles on their roofs and therefore it is a good reason to invest in that company. Although, price matters. There is no company so great, that a high enough valuation can’t make it a bad investment. Now is Telsa at that point? I do not know. In the long run, all that matters is fundamentals. The current stock price is pricing in incredible fundamental strength in the future. You are prepaying for that expectation.

Finding the fair value of a stock should be equivalent to the present value of all future cash flows discounted at certain rate. If a company produces zero cash flows after 1 year, then you need a little more than normal in year 2 to compensate for that and so on and so on. But what are the future cash flows and what discount rate do you use? That’s where it gets hard.

Imagine you are investing in a lemonade stand franchise that generates $1,000 annually in pre-tax earnings, and those earnings will grow at a clip of 30% annually for the next 10 years, 15% annually for 10 years after that, and 7% indefinitely after that. How much would you pay to buy the entire company?

I do not think many investors get to that level of detail, it’s more of a gut instinct that “I like that company and I want to buy it”. Unfortunately sometimes that works just by sheer luck! Evidence shows that sometimes monkey throwing darts at the Wall Street Journal can beat professional money managers, but I wouldn’t bet my life savings on a dart throwing monkey (although I would like to witness that sometime in my life).

This post is not a recommendation for or against Tesla, General Motors, of Ford. I do not own any of these companies and do not intend to.

Scott McNeely was the CEO of Sun Microsystems, a company that during the dotcom bubble went from $5 a share to $64 and was trading at 10 times their annual revenues. A few years after the bubble collapsed he had this to say about where the stock price was trading (full article here: Article):

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?”

While I do not recommend owning individual stocks, hopefully this provides a small glimpse into the thrill, anguish, and head scratching that goes into security selection.