Decades ago, we came up with a phrase to describe a growth stock’s long-term growth cycle, describing the three phases a stock will go through during its life: Romance, Transition and Reality. The Romance phase is when the stock makes its biggest gains; it’s when investors fall in love with the story and potential, as well as the initial rapid growth. Then comes the Transition phase, when the stock often stagnates or declines for many months or even years, as investors start to see the warts of the story and the stock’s nosebleed valuations come back into line. Then, finally, you get the Reality phase, when the company is more mature and the stock is judged based on cold, hard facts. If the firm is successful, the stock will head up (though at a more measured pace than in the Romance phase), and if it’s not, it will remain in the doghouse.
That pattern—Romance, Transition, Reality—is what we’ve seen over and over again during the past few decades. However, in recent years, something changed; many leading companies have ended up with two or even three Romance phases, usually as they roll out new, blockbuster products or services. The classic example is Apple, which enjoyed Romance phases with the iPod and iTunes … then again with the iPhone … and a third time with the iPad, each of which revolutionized the industry and created a huge upturn in earnings.
We’re not exactly sure why there have been so many “follow-on” Romance phases in recent years. If we had to guess, it would be the relative lack of entrepreneurship in the U.S. today—maybe the so-so economy of the past 15 years in general has convinced many would-be entrepreneurs to stay put and rise through the ranks of their current firms. Whatever the reason, many of the big winners like Apple, Priceline and Netflix have enjoyed two or three Romance phases. All of that leads us to Tesla Motors (TSLA), which enjoyed a stunning Romance phase in 2013 and 2014, rising from 40 to 290 in less than a year and a half on the success of its Model S all-electric sedan. In short, Tesla redefined a tiny industry (electric vehicles), emphasizing style and luxury on top of its eco-friendliness. Then came the stock’s Transition phase—sales of the Model S remained strong but leveled out, and while there was some initial buzz about its Model X crossover, production delays (and some good-not-great reviews) made it something of the stepbrother to the Model S. The result was red ink (the company lost $2.30 per share last year) and a stock that meandered sideways for more than a year following its September 2014 high, and then plunged as low as 141 during the early-2016 market decline.
Since that low, the stock has roared back to life, and the reason is obvious—the unveiling of the company’s Model 3 sedan has been bit a hit! Without getting into all the details, the car will have a reasonable base price of $35,000 (though Tesla anticipates the average selling price will be above $40,000 once options are included) and a range north of 200 miles, making it attractive for millions of buyers.
And pre-sales (which required a $1,000 down payment) have confirmed that—within a couple of weeks of its showing, the company has booked a whopping 325,000 orders for the Model 3. That’s about $11 billion worth of cars! By 2020, Tesla is aiming to boost production capacity to 500,000 cars per year, and it certainly seems that demand for all its models will be strong enough to meet that supply.
Now there’s a long way from today (pre-orders) to late 2017, when the first Model 3s are expected to be delivered. But that’s not a bad thing; again, in a Romance phase, investors are looking ahead, imagining great things as they begin to factor in the “unforeseeable and incalculable” (to quote the late Tom Phelps) growth potential of the Model 3 and the firm’s other models. Their latest calculation: If Tesla succeeds in boosting production to 500,000 cars per year by 2020, up 10-fold from 2015, earnings are going to be out of this world.
Put it together, and we think Tesla’s stock may be starting a new Romance phase, led by the potential for the Model 3. Moreover, earnings estimates show excellent growth for this year ($1.28 per share) and next (north of $3), and the stock’s persistent rebound since early February bodes well. We have TSLA back on our watch list—a normal cooling off period after the recent run could provide the opportunity to get on board. WATCH.