- Rob Arnott pioneered fundamental indexing as an investment strategy to outperform the market.
- He believes the electric vehicle market is at the epicenter of a “big market fallacy.”
- Arnott recently talked about the rise in EV stocks and why Tesla could be in trouble.
- See more stories on the Insider business page.
Rob Arnott is the founder and chairman of Research Affiliates, where he spends his days developing the investment strategies used by some of the world’s largest asset management companies.
The fundamental indexing pioneer joined Bloomberg Radio’s Barry Ritolz in a recent episode of Masters of Business to discuss the misconceptions of the electric vehicle market and why he believes incumbent carmakers are a big threat to Tesla’s future.
Electric car megalomania
It’s never good for an investing legend to address an entire industry, but that’s exactly what Arnott did in a recent Research Affiliates report. In the report, he explains that the so-called “big market fallacy” occurs when innovation or disruption opens up opportunities in a new or existing market.
“A sign of a big market fallacy is when all firms in an emerging industry grow together, even if they are often direct competitors,” Arnott wrote. “Investors are getting so excited that each firm is judged to be the ultimate winner in a big emerging market, even though this is a misnomer: the sum of the parts cannot be greater than the whole.”
Arnott believes the electric vehicle market is a perfect example of an industry clouded by a big market fallacy. Investor hype around Tesla reached new heights last year when the company reached its production and profitability targets and joined the S&P 500. Tesla shares are up over 700% in 2020, and Tesla’s market capitalization reached 752 billion by the end of January 2021. dollars.
“At this market capitalization, Tesla accounted for about 75% of the total market value of the EV group and 35% of the market value of the entire automotive industry,” Arnott writes. “Such a huge market capitalization only makes sense if Tesla is expected to dominate the entire automotive industry, not just the electric vehicle market.”
Since Tesla established its dominance in the past year, its competitors’ shares should have dropped. After all, when Tesla grabs the lion’s share of the market, new EV companies will be forced to fight for leftovers.
Instead, when Tesla shares rallied last year, they pulled the rest of the EV market with them. Investors have been enthusiastic about investing in EVs across the board – regardless of the real value of these companies.
Arnott details this in his research report, writing that as of the end of January 2021, “the total market value of eight electric vehicle specialists in our universe was $ 1.0 trillion after a 618% year-on-year growth, almost equal to the combined value of traditional automakers. $ 1.1 trillion. “
Last year, the tide lifted all boats, and Tesla was the catalyst that propelled the rest of the EV market skyward. But in the end, the hype in the electric car industry seemed to eclipse Tesla, as new EV stocks like Nikola and NIO outpaced Tesla’s.
“At its peak during the last quarter, Tesla was worth 34 times its annual sales,” Arnott said in an interview with Ritholtz. But compared to seven other electric vehicle specialists Arnott oversees, Tesla was the second cheapest, while other companies’ price-to-sales ratios ranged from 20 to over 10,000 sales.
And this, according to Arnott, is the problem.
“I have no idea if Tesla will justify the current price,” he said. “I doubt it very much. But I am absolutely convinced that the collective electric vehicle market is not worth its current price. ”
The road to electric vehicle dominance
Arnott believes that the EV market is overpriced compared to its current production level, especially when you consider the production volume of conventional car companies.
“If you look at the EV industry collectively, it costs about 80% of the value of all other car manufacturers combined,” says Arnott. But over 50% of all electric vehicles are produced by existing players in the automotive industry such as Toyota and Volkswagen.
“The electric vehicle specialists thus make up less than half of the electric vehicle market, and their overall valuation is almost the same as that of companies that collectively produce nearly a hundred times as many vehicles.” According to Arnott, it doesn’t make sense.
In short, says Arnott, the future of the EV industry doesn’t necessarily lie with EV-only companies like Tesla. In fact, he thinks “Tesla is an overpriced company and investors will be very lucky to have positive returns over the next 10 to 20 years, very lucky indeed.”
Arnott doesn’t deny that Tesla was a pioneer in the electric vehicle industry, but he doesn’t know if the company will be able to maintain its current leadership forever – not when incumbent automakers like Toyota might simply outperform newcomers like Tesla.
“When Toyota decides to spend more on electric vehicle innovation than Tesla can generate in gross revenue over the next three to five years, and does that every year, well, Tesla will have some serious competition.”
While investors may be fascinated by Tesla today as it shakes up the dull old auto industry, the industry’s extremely competitive and capital-intensive nature favors larger, more established players. Tesla may have an edge, but companies like Toyota and Volkswagen are quickly shifting their focus to the burgeoning EV market. Eventually, Arnott warns, the pendulum could swing in their direction.
“The whole concept of the big market fallacy is that people look at disruptors and say that these destroyers have a future, they know what is coming, they are perfectly prepared for this and do not notice the fact that destroyers are being destroyed. It happens. Over and over and over. “