Here’s Why Tesla Will Never Be Able to Satisfy Investors

September 9, 2016, 5:00 PM UTC
Tesla Unveils New Battery System
Photo by Kevork Djansezian—Getty Images

It will take more than an email to recharge Elon Musk’s relationship with Wall Street.

On August 29, Musk sent a missive to Tesla’s employees saying winning back investors love is just one simple flip of the switch away. Musk wrote: “We will be in a far better position to convince potential investors to bet on us if the headline is not ‘Tesla Loses Money Again,’ but rather ‘Tesla Defies All Expectations and Achieves Profitability.’ That would be amazing!”

Amazing perhaps, but probably not as electrifying at least with investors as Musk hopes. Shares of Tesla (TSLA) are down 18% this year.

In fact, Tesla is already predicted to turn a profit, about $110 in the second half of 2016, which is supposed to rev up to $200 million in 2017.

The problem is in order to make those profits Tesla’s cash is burning up faster than some of its early engines.

Musk and others have invested $14 billion in the car company in the past 13 years. Most of that investment, though, has not come from cash garnered from making and selling its Model S sedan and Model X SUV, but from fresh financings—chiefly from sales of stock, including a successful $1.7 billion offering in the second quarter. In fact in the next two years, Tesla is expect to raise another $9 billion in capital—in order to ramp up to producing 500,000 cars a year and complete the Gigafactory, which is Musk’s giant battery manufacturing facility in the Nevada desert.

Tesla couldn’t be reached for comment before the publication of this article. Fortune will update the story with any comment from the company.

Keep in mind that it’s not unusual for startups to devour tons of cash on their path to turning big profits;Amazon is a notable example. The problem is that the more capital that Tesla raises and assets its adds, the steeper the path to a sizable return. Put another way, will the company’s profits ever be large enough to justify all of the enormous amounts of cash that is fueling that growth?

There’s a way to find that out.

The best yardstick is COROA, or “cash operating return on assets,” a measure developed by Jack Ciesielski, an accounting guru and author of the Analyst’s Accounting Observer. COROA is the best methodology for assessing how smartly executives are deploying all the cash given to them by stock and bondholders. I have used COROA before, most recently on Apple.

It’s the purest measure of the basics: how much cash a company is generating on each dollar that it has invested in its business.

For this project, Ciesielski made one special change from his normal formula. Instead of subtracting R&D expense from cash from operations, as required under GAAP, he capitalized research spending as an asset on Tesla’s balance sheet, and made the optimistic assumption that those “investments” hold their value forever. “Tesla has a lot of R&D that lowers cash flows but should produce better returns down the road,” says Ciesielski.

So how well is Tesla doing, and how much does it need to improve? (All of these figures exclude Tesla’s proposed acquisition of SolarCity, a deal that would make the path even more difficult.) In 2015, Tesla generated operating cash flows, with R&D added back, of $235 million, on average total assets of $9.7 billion, a number that includes capitalized R&D. Hence, its COROA stood at 2.4%. Worse, Tesla added $3.9 billion in average assets in 2015, yet its operating cash flows actually dropped.

General Motors and Ford did far better, posting similar COROAs of 8.7% and 9.3%, respectively.

OK, one might say, but Tesla, unlike GM and Ford, is still in the capital hungry, rapid-ramping phase. What one really should be doing is projecting what Tesla must accomplish to match GM and Ford once it starts making the huge volumes it’s promising. That’s when it starts to get really ugly.

By 2018, Musk pledges to be making 500,000 vehicles a year, ten times the current number. Using projections from J.P. Morgan Chase, I estimate that Tesla will hold average assets (including accumulated depreciation and capitalized R&D) of $23 billion in 2018, more than twice the number last year. That means to reach Ford’s and GM’s average COROA of 9%, Tesla would need to raise its operating cash flow from $235 million to $2.1 billion—an improvement of eight times or almost $1.9 billion—and it only has two years to get there.

Could it? It’s possible. If Tesla manages to sell gigantic volumes at close to the kind of fat margins it now reaps on its extremely pricey models, then it’s profits will soar. In the August 29 email, Musk noted that Tesla is on the “razor’s edge” of achieving positive cash flow from operations for the third quarter. Indeed, the numbers for the second quarter showed a negative $99 million in cash from operations, a big improvement over previous quarters.

The problem, though, is that all major car makers are either improving or developing electric cars. By 2018, Tesla’s lower-priced, mass-market Model 3 will face plenty of competition, which is sure to eat into profits. “These are like mobile phones on wheels,” says Ciesielski. “They’ll need huge sales numbers and huge margins, but they’re targeting the lower end, where it will be harder to get those returns.”

Even with this tough road ahead, investors still love Tesla. It boasts a market cap of $30 billion, two-thirds that of GM and Ford, with fraction of a fraction of their sales. By 2018, that market cap will need to increase another $7 billion, or roughly the equivalent of the total market cap of retail chain Kohl’s, to at least $37 billion to hand investors the returns they’re expecting.

Bottom line: When it comes to Tesla’s stock, you have two choices, you can either be on the side of a “innovator” or on the side of numbers. You can’t pick both.

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