Image source: Olaf Kraak via Shell plc
Over the past 12 months, Shell (LSE:SHEL) – a FTSE 100 company: generated £53 billion in operating income. At that moment, tesla (NASDAQ:TSLA) generated $13 billion (£10.4 billion).
Despite this, Shell’s total stock market valuation (£182bn) is 68% lower than Tesla’s (£575bn). I think this shows something important about UK stocks.
Investing 101
Lets start by the beginning. Investing in stocks and shares involves buying part of a company with the hope (or expectation) that the underlying business will generate enough cash to generate a decent return.
This means that the investment equation comes down to two things. The first is how much the company is going to earn and the second is how much it costs to buy its shares.
However, it is important to note that investing is a long-term activity. So the question is not just how much a company is going to earn next year or the year after, but how much it is going to earn in 10, 20 or 30 years.
By purchasing Tesla shares at current prices, investors express the opinion that the company will make three times as much money as Shell in the future. This despite the fact that he currently earns 80% less.
Could that happen? Perhaps, it depends on what the future of each business is like.
Shell
Shell’s recent gains have been boosted by unusually high oil prices, so investors should not assume that recent profitability levels will persist. But the current share price indicates that they are not doing so.
Right now, the average price-to-earnings (P/E) ratio for FTSE 100 shares is 11. In the case of Shell, the stock is trading at a P/E multiple of eight, implying the market is expecting profits . be smaller in the future.
However, by the same token, based on the company’s average earnings over the past 10 years, the stock is currently trading at a P/E ratio of 14. This suggests investors think the next decade will be better than the last .
I don’t think this is unreasonable. I expect oil prices to be slightly higher on average over the next decade and anticipate higher profitability for Shell as a result.
tesla
I think Shell could average £14 billion a year in operating income over the next decade (around 5% higher than its average over the last 10 years). At current prices, that’s an annual return of 7.7%.
For Tesla to manage something similar, it would have to generate an average of £44 billion a year. This is a growth rate of 25% per year on the £10.4bn the company managed over the last 12 months.
There is absolutely no doubt that Tesla’s profits are going to grow. The real question is whether they can grow that fast or not.
Self-driving cars, batteries and electric vehicle infrastructure provide the company with growth potential. But even its staunchest defenders would accept that the market is currently pricing in high expectations for the business.
Silly takeaways
There is a broader lesson here for investors. Overall, FTSE 100 shares trade at a significant discount to their US counterparts.
There are times when that is clearly justified. But there are also times when the gap is too wide.
Investing involves buying stocks for less than they are worth. And I think the best chance of finding them is to look where the prices are low.