Stunning: Is Tesla Stock Really Cheaper Than Adobe?

Why is the market letting you buy $26 of Tesla’s Revenue for a price of roughly $350 per share of Tesla stock – implying a price-to-sales, P/S, multiple of close to 13.5x – while for a seemingly lower flying stock like Adobe (NASDAQ:ADBE), you need to shell out closer to 21x? Adobe’s 21x multiple is based on its $11.2 billion in 2019 sales ($22.70 in sales on a per-share basis) and a stock price of $470. Can Tesla stock really be cheaper than Adobe and deserve a lower price to sales multiple? The contrast isn’t a whole lot better if you use the sales figures from the last four quarters instead of the last fiscal – using numbers for the last four quarters, Tesla’s P/S is about 13x, compared to Adobe’s 19x. More importantly, the mismatch isn’t due to Tesla’s sharp stock price decline today, as its P/S multiple would be 18x (as opposed to Adobe’s 19x figure) even if its shares were currently trading at the all-time high of $500 seen a couple of weeks ago.

Here’s what’s going on. The price-to-sales or P/S multiple for a company is higher when the sales growth is higher, and it has a demonstrated ability to translate those sales to profits, with an expectation to do so consistently.

Sure Tesla’s revenue growth is much higher (55% average annual revenue growth over the last 3 years vs about 24% for Adobe). However, Tesla’s returns are low. Specifically, Tesla wasn’t profitable in 2019, and over the last 4 quarters, Tesla’s net income margin (net profits as a percent of revenue) stood at under 2%. Using another measure of return, Tesla’s 10% free cash flow margin (net profits adjusted for non-cash expenses as a percentage of revenue), is also lower compared to 18% for the more mature Adobe. Understandably, the market sees significantly more risk in Tesla’s ability to translate its revenues to profits and cash flow, compared to Adobe’s proven profitable history. 

What about the P/E multiple?

In that case, some might say, it is obvious – not stunning at all, that Tesla has a lower P/S multiple than Adobe. In fact, Tesla’s current P/E at around 180x (based on earnings over the last four quarters) is way higher than Adobe’s P/E multiple of 63x. But is that enough to quickly conclude Tesla is more expensive than Adobe? Not really.

Comparing the P/E multiple for a company like Tesla that has barely had its first 4 quarters of profits (from Q3 2019 to Q2 2020) with a much more mature company like Adobe can be misleading. In such cases, the relative P/S multiple is arguably a more informative metric. In contrast to the massive gap in the P/E multiples, the P/S multiples for the two companies are curiously close – and worth looking at further.

In fact, let’s step back to look at the fuller picture based on Revenue Growth, Returns (ability to generate profits from growth), and Risk (sustainability of profits).

See our dashboard Tesla vs. Adobe: Is TSLA Stock Appropriately Valued Given It’s lower P/S Multiple Compared to ADBE?, parts of which are summarized below.

1. Revenue Growth

Tesla’s growth has been stronger than Adobe’s over the last three years, with Tesla’s Revenue expanding at an average rate of 55% per year from $7 billion in 2016 to $24.6 billion in 2019, versus Adobe’s Revenue which grew 24% from $5.9 billion to $11.2 billion.

• Tesla’s growth is driven by the launch of new electric vehicles such as Model 3 and Model Y and the opening of a new factory in Shanghai. Adobe, on the other hand, has benefited from expanding sales of its creative software under a software-as-a-service model and an increasingly strong position in the digital marketing space.
• Now, the low-interest-rate environment following Covid-19 has made investors take a longer-term view, valuing higher growth companies more richly. And this largely explains the sudden jump in Tesla’s valuation over the last two quarters. For perspective, Tesla’s market capitalization stands at over $330 billion, compared to about $235 billion for Adobe.

2. Returns (Profits)

Coming to Returns, Adobe, a more mature company with an asset-light business model, has a clear edge over Tesla.

• Tesla’s Free Cash Flows as a percentage of revenue stood at about 10% in 2019, below Adobe’s 18% over the same period. On a Price to Free Cash flow basis, Adobe is valued at a more attractive 118x compared to over 162x for Tesla.
• Tesla’s Return on Invested Capital (ROIC) is also much lower compared to Adobe’s (4% vs. 40%).

However, Tesla’s return metrics should improve as delivery volumes continue to scale up, the company’s past research and product development spending start to pay off, and its increasing emphasis on software boosts gross margins. (related: How Do Tesla’s Software Sales Impact Its Gross Margins?)

3. Risk

Tesla looks like the riskier of the two companies from the perspective of financial leverage.

• Tesla’s Debt to Equity ratio stood at over 170% in 2019, as it has been taking on debt to fund its manufacturing capacity expansion. In comparison, Adobe is almost debt-free.
• That said, Tesla has adequate liquidity to manage its operations and service its debt, with its cash position standing at about $9 billion in the most recent quarter, with a cash to assets ratio of about 20 percent, which is roughly in line with Adobe’s ratio. Further, Tesla raised another $5 billion via a share offering, which should provide the company with a further cash cushion.

But there’s more to the risk story. Tesla’s P/S multiple has swelled from just 3x at the beginning of the year to its current level of 13x. The metric has spiked for Adobe too from 14x to 21x – as we detail in our dashboard about Tesla vs. Adobe. In other words, the market sees much less risk to Tesla being able to generate Adobe like profits – soon!

The net of it all

In summary, though Tesla’s sales growth is higher, Adobe’s higher price-to-sales multiple compared to Tesla may, in fact, be justified based on Adobe’s much lower risk to translate its sales to profits. This is all sensible unless you believe in Tesla’s massive self-driving leadership, and that Tesla is essentially a software-as-a-service company, with a hardware component. Maybe not too dissimilar from Apple that owns both hardware and runs its iOS software. Net advantage moves back to Tesla if you finally believe in this one most important Tesla metric: Tesla’s Time Horizon.

For Adobe – Tesla or not – isn’t about 19x sales a lot to pay for Adobe? It is indeed. For perspective, the S&P 500 has an average price-to-sales multiple of just 2x, but Microsoft’s P/S ratio is 11x, and the software industry average is about 8x. ^[1] Overall, these are unusual times – the unusual liquidity from the Fed, unusual attraction for all things software. Well, Adobe as a profitable software company is a bit like royalty! 

While the EV space offers high growth, what if you’re looking for a more balanced portfolio instead? Here’s a top-quality portfolio to outperform the market, with over 100 percent return since 2016, versus 55 percent for the S&P 500. Comprised of companies with strong revenue growth, healthy profits, lots of cash, and low risk. It has outperformed the broader market year after year, consistently.

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1. Revenue Multiples by Sector, NYU Stern [↩]