Have the laws of physics governing the auto industry changed so fundamentally that they no longer apply?
Investors apparently believe so, as in recent days they’ve bid up shares in Tesla, Rivian and Lucid to nosebleed valuations, pushing the market valuations of the three EV startups past those of major international automakers with much longer histories—and much higher revenues.
Ever since Tesla added over $100 billion to its market cap thanks to an order worth no more than $4.5 billion from formerly insolvent rental agency Hertz, electric vehicle stocks have been levitating far, far above the traditional industry giants.
On Tuesday alone, Rivian gained 15%, when options contracts on the stock began trading on Nasdaq and the CBOE a week after its IPO listing. With roughly $150 billion in market cap, a company that has barely produced any cars has already overtaken Volkswagen Group as the third most valuable automaker behind Tesla and Toyota. Lucid meanwhile is worth more than both Ford and Chrysler parent Stellantis—and nearly as much as the other member of the one-time Big Three, General Motors.
“It’s a gold rush and everyone is looking for the next nugget,” Bernstein analyst Arndt Ellinghorst told Fortune.
A ‘gamma squeeze’?
Retail shareholders are believed to be doing much of the heavy lifting, as they place risky bets via derivatives to maximize returns. Without access to third-party funds like money managers to heighten the stakes, they hope to elicit a rally by loading up on short-dated call options. That is because market makers on the other side of the trade typically buy shares to fully hedge their position.
When executed successfully, the move is known as a “gamma squeeze”. The Greek letter gamma quantifies the rate of change in the value of the options versus movements in the underlying stock. Numerous YouTube channels offer tutorials on all aspects of derivatives trading, even though there’s always the chance that out-of-the-money contracts can ultimately go to zero. (This is something that rarely happens when investors opt to hold the shares themselves instead, because equity is backed by tangible assets.)
“Charismatic tech founders that can communicate a simple and obvious vision of the future will draw in the most capital from retail investors. This is true of Tesla, and it goes for Rivian, too,” wrote Daniel Clarke, thematic analyst at analytics firm GlobalData, in a statement on Wednesday. “More traditional investors scorn Tesla and Rivian’s jaw-dropping market caps because of the huge gaps between their current revenue and their valuations.”
This is because institutional investors have very clear criteria why they own certain stocks, when and at what prices, whereas retail shareholders freed of these fiduciary constraints can afford to be “valuation-agnostic”, as Ellinghorst describes it.
The Bernstein auto analyst said this is one contributing factor why EV stocks appear to be in a self-sustaining virtuous spiral, with gains in one triggering a rally in the others that then feed back into the first.
“Obviously we have the [central bank-enabled] liquidity that we have these days, and social media is driving all sorts of narrative-based investing,” he said. “All I can say is be mindful what can happen with your money, because at the end of the day what matters is the cash flows.”
‘Next Amazon’ talk
However, Jefferies analyst Philippe Houchois, another veteran industry watcher, suggests it may be the legacy carmakers that are overvalued. They are saddled with stranded combustion engine assets and struggle to adapt their mindset to the new, software-enabled electric future.
“Tesla challenges everything the industry does. And everything the industry does is usually disappointing, when it comes to returns,” he told Fortune.
Elon Musk’s company enjoys a 10-year head start in EVs, its software expertise is considered benchmark, and its battery technology is superior to anything currently on offer from traditional automakers. Now Tesla is even scaling up, with Musk predicting the Model Y will become the world’s best-selling vehicle—EV or not—in 2023. By that time, two new factories in Texas and Germany will have fully ramped up, doubling production capacity of the mid-size crossover.
Houchois likens Tesla’s potential to Amazon. Jeff Bezos’s company is perhaps best known as an online retailer but it also possesses the highly profitable subsidiary Amazon Web Services (AWS), which pioneered the hyperscale cloud computing business.
“It’s true that it is very, very difficult to justify Tesla’s share price if you want to apply traditional valuations,” he said. “But Amazon 20 years ago was considered just a bookseller. Tesla’s auto business could be just a first step that leads to other things, as its brand can be universally applied to almost any sector.”
For example, Musk announced in August plans to develop a humanoid worker robot dubbed “Optimus” that could navigate its way around with the help of artificial intelligence Tesla is already developing to enable self-driving cars.
Whether its two lesser known peers have similarly grand ambitions is unclear. Lucid only just started delivering its first cars last month—unusual given it already listed its shares by then via a SPAC reverse merger. Yet it would arguably still be just a battery supplier had it not appointed the former Tesla Model S chief engineer as its CEO.
Rivian too went public just as it began shipping its first R1T electric trucks to customers. It could have a bright future ahead of it, though, given it counts Amazon as its single largest investor.
“Lucid and Rivian enjoy certain advantages given they do not suffer from legacy issues, they do not need to ‘unlearn’ as it were,” Houchois said. “But the question remains do they have a technological edge and can they envision other addressable markets outside of cars?”
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