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Friends,

Last week, Tesla's stock fell 10% after reporting earnings. All three of us are shareholders, so we took no pleasure in watching the price plunge. However, the report was underwhelming, and the stock is richly valued. Wall Street's reaction makes sense.

That said, we've noticed a lot of misunderstanding about changes in Tesla's strategy over the past year -- namely, its price reductions. Some investors think it's a bullish sign ("Tesla is playing offense!"). Others think it's a bearish signal ("Tesla's demand is weak!")

The key for investors to understand what's going on is this visual: the Business Growth Cycle.

By the end of 2022, Tesla was firmly in Stage 5: Capital Return. Its operating margins neared 17% -- far better than any other major automaker. The company was fully optimized for profitability at its current margin profile.

But then, Musk & Co. started to drop prices substantially. The cheapest Model Y you could buy on January 1, 2023, was $66,000. Today, it's just $44,000. That $22,000 price drop has obliterated its margins and caused the company to intentionally move backward to Stage 4: Operating Leverage.

Why would Musk make this move? We can think of a few reasons:

• Tesla's scale makes it the low-cost EV producer. By lowering prices, Musk believes he'll capture more market share and put the hurt on rival EV makers.
• Lower prices align with the company's mission of "Accelerating the World's Transition to Sustainable Energy"
• With $23 billion in net cash, Tesla can easily afford to accept lower profits today while still investing aggressively in future growth -- via the Cybertruck, Semi, Optimus bot....etc.

Mind you, this doesn't mean this is how it'll play out. But there is a daring logic to it.

With interest rates rising, buyers are pinched. If Tesla offers a car for $44,000 that costs $37,500 to make, it's still generating a positive gross profit. But other automakers -- who have yet to achieve operating scale to produce EVs at a similar internal cost -- don't have that luxury. This is Musk using Tesla's unfair advantage (low-cost production) in a Machiavellian way.

This aggressive pricing strategy does not automatically mean that Tesla will be a good long-term investment. Trading near-term profits for market share might be a good business decision, but it could be a terrible shareholder decision. Moreover, Tesla's valuation is still pricing in substantial market share gains from here, not to mention successful future product launches and huge self-driving profits. None of those things are guaranteed to happen.

Instead, we view what's happening as a wonderful real-time display of what can happen when a company uses a strong moat (in this case, low-cost production) to put the hurt on competitors.

The move is a huge win for consumers and EV adoption in general. Will that translate into a win for Tesla's shareholders? Only time will tell.

Wishing you investing success,

- Brian Feroldi, Brian Stoffel, & Brian Withers

P.S. Enrollment in our newest cohort-based course, Advanced Financial Statement Analysis, is officially open! Click here to enroll using the coupon code LASTCALL200 (expires on Sunday, Oct 29th at 11:59 PM EDT).

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