• Mark Zil

Is It Time to Invest in Electric Vehicle Stocks?

Many popular stocks' shares are down significantly in 2022.

Many investors are bullish on the prospects of the electric vehicle (EV) industry, with battery-powered transportation aiding in the fight against climate change. EV adoption is underway, and the sector has become an investment craze in 2021, thanks to Tesla's rapid rise (TSLA 5.48 percent).

However, by the middle of 2022, much of that enthusiasm has waned, with share prices significantly lower than all-time highs, potentially providing a buying opportunity for long-term investors. Let's see if now is the time to buy some EV stocks.

The ups and downs

It is unclear why investors became so enthralled with EV stocks, but the fervor peaked following the March 2020 market lows. For example, from March 2020 to the end of 2021, Tesla and Nio (NIO 7.77 percent) both soared over 1,000 percent, far outpacing the S&P 500's 89 percent total return.

The majority of these gains were not the result of these two companies' fundamental growth. While Tesla's and Nio's gross profit per share increased by around 100 percent and 192 percent, respectively, the majority of that growth was due to multiple expansions, with both stocks' price-to-sales ratios (P/S) reaching 30 in early 2021. The average automaker trades at a P/S closer to one.

On the back of this hype, many EV companies went public with much fanfare in late 2020 and throughout 2021, driving initial public offering (IPO) share pops not seen since the dot-com bubble in 2000. There is no better example than Rivian Automotive, an EV manufacturer whose stock was valued at more than $100 billion despite the fact that it had yet to produce a single vehicle.

EV stocks have dropped significantly by 2022. To begin the year, all major EV companies are trailing the S&P 500, with stocks down 30 percent or more in just a few months. Rivian, the group's most overvalued stock, has seen its shares lose 72 percent of their value this year.

There is no better example than Rivian Automotive, an EV manufacturer whose stock was valued at more than $100 billion despite the fact that it had yet to produce a single vehicle.

The long-term tailwind is strong

There is no doubt that EV investors were correct about the industry's enormous opportunity. Analysts predict that global EV sales will reach $800 billion per year by 2030, making it one of the world's largest industries. With over 60 million new cars sold globally each year and the average price of a new car in the tens of thousands of dollars, it's easy to see why so many companies are investing in the EV space: the opportunity is enormous.

Furthermore, with many governments around the world incentivizing businesses to switch to EV manufacturing, humanity as a whole has decided to make the switch. Gasoline-powered vehicles have no chance and will likely be obsolete within a few decades, if not sooner.

So, with stocks down but the long-term opportunity intact, the stocks should be a buy, right? Not so quickly...

Why am I still avoiding it?

Even though many EV stocks are down from their highs, that doesn't mean they're a good buy. There are two primary reasons why I am avoiding these companies as potential investments.

First, the automotive industry has proven to be extremely competitive and difficult to win over the last 100 years. Due to the cyclicality and capital intensity of car manufacturing, only two automakers in the United States have never declared bankruptcy or simply folded (Tesla and Ford).

Hundreds of carmakers sprang up in the early twentieth century during the initial automotive revolution, but the majority failed due to how difficult it is to keep businesses running during down cycles. This seems likely to happen with EV manufacturers in the coming decades, and I'm not sure who will come out on top.

Second, the stocks are still highly valued in comparison to legacy automakers. For example, Tesla has a price to free cash flow (P/FCF) ratio of more than 100, whereas Ford has a P/FCF ratio of only 13.8. Tesla may be growing faster than Ford, but the legacy automaker isn't sitting back and watching the EV revolution pass it by.

Ford is investing tens of billions of dollars in EV manufacturing this decade, alongside investments from other major automakers such as Volkswagen and Toyota, which will significantly increase competition for consumer spending. This increases the risk for investors in pure-play EV stocks, particularly those trading at exorbitant earnings multiples.

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