Where Tesla departs from the Mag 7

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Good morning. The news outlet/hedge fund Hunterbrook, in its debut article/short sale, sent the stock of United Wholesale Mortgage down 8 per cent. Hunterbrook accused UWS, a mortgage lender, of cultivating loyal mortgage brokers while telling customers they were independent. But all anyone in our business could talk about was whether a new journalism model was taking root. Any thoughts welcome: robert.armstrong@ft.com and ethan.wu@ft.com.

Tesla and the unsettled EV market

Yesterday we wrote about one of two faltering Magnificent 7 stocks, Apple. Today we consider the more severe case, Tesla, which has lost a third of its value this year:

The sell-off continued on Tuesday, after Tesla reported a 9 per cent year-on-year decline in first-quarter vehicle deliveries, missing expectations badly. Tesla’s stock is notoriously volatile, speculative and hard to value. But the list of problems for Tesla’s business is long and growing: price cuts pinching margins, Chinese electric vehicle competition, bad corporate governance, political risks and now falling volumes. 

Worse fears are out there, too. Some argue Tesla may be caught up in a global EV bust that is only just beginning. The story goes something like this: Automakers convinced themselves that EVs are awesome, consumers will love them and governments will subsidise them. No one wanted to get stranded with a defunct internal combustion engine business. So everyone piled in and production shot up, but near-term demand hasn’t materialised. As Peter Campbell laid out in the Financial Times yesterday:

The global auto industry manufactured 10.5mn electric vehicles last year — and expects to produce 13.5mn this year . . . 

In 2025, on current projections, output will rise even further to 18mn — a 70 per cent increase in global EV output in just two years, the forecasts show. Yet sales, the same data set predicts, will lag even further behind. EV interest last year resulted in sales of 9.5mn vehicles, but the figure is only expected to be 9.8mn this year. 

Some investors are now privately warning about an “enormous misallocation of capital” across the industry.

It’s not hard to imagine a bloodbath of spiralling price cuts, automaker losses and production retrenchment. 

But another interpretation is possible. Perhaps wobbly EV demand comes and goes. JD Power surveys of shopper consideration don’t show any big drop-off in consumer desire to buy EVs. Likewise, S&P Global Mobility surveys suggest stable EV loyalty, measured as the share of EV owners whose next car was an EV, especially for Teslas. Citi’s global autos team tells one sanguine story:

We believe Tesla likely hit natural growth saturation points . . . we [also] believe Tesla’s Model 3/Y also experienced product age headwinds. Said differently, we learned that [like traditional cars, an EV] is still an emotional purchase where saturation and product age can affect demand more than other factors, including price . . . 

We believe the US is structurally well set up for a potentially rapid EV adoption period given it averages almost two vehicles per household. In effect, EV adoption has not really started . . . If consumers were to rapidly opt to become a one [internal combustion engine vehicle] and one EV household, EV demand could, in theory, rise overnight.

If overall EV demand is stalling rather than crashing, then there’s scope for bullishness on Tesla’s business. The company’s upcoming $25,000 car, set for 2025, could unlock a new tranche of customers. Chinese demand could start rising again. The clunky rollout of subsided US charging stations could speed up, making EVs more attractive. 

These are hard calls and we’re in no position to forecast the EV supply-demand balance. But the tensions highlight a big difference between Tesla and the other Mag 7 stocks: Tesla’s industry economics are much less settled. Alphabet, Meta, Microsoft and Apple hold dominant positions in increasingly mature industries (digital ads, enterprise software and smartphones). Amazon and Nvidia are less secure but still enjoy deep competitive moats in their niches (retail platform data and logistics and class-of-their-own AI chips). Tesla, however, holds a fragile lead in an immature industry. Lumping it in with the Mag 7 was a mistake. (Ethan Wu)

Diversity and profitability

A serious professional problem faced by financial journalists, business school professors and investors alike is that it is hard to say anything precise about the relationship between management skill and corporate performance. It is obvious that leadership matters to financial results; we observe extreme examples of the link between the two, both positive and negative, all the time. But the relationship is difficult to generalise about, quantify or predict.

As a result, the financial effects of management quality are often measured by treating them as a residual. Look at the relative performance of a company, control for everything you can think of and measure — company size, industry, market shifts, geography and so on. Whatever is left over is attributable to management. It’s not a totally satisfactory method (how does it account for plain old luck, for example?) but it’s often the best one can do. 

Another method is finding matched pairs of companies — in similar industries, of similar size, deploying similar technologies — and following each very closely over a long period, to observe how management choices lead to diverging outcomes. The management guru Jim Collins uses this technique, and while he thinks it generates durable insights, these are not reducible to a single number, and there is always more complexity to be accounted for. “I always feel I have to keep peeling layers back,” Collins told me.

A recent paper brings this tricky epistemological problem into the politically thorny realm of leadership diversity. 

Over a number of years, McKinsey has released several widely read and cited reports presenting the business case for diversity in corporate leadership. The centrepiece of the McKinsey reports was a series of studies that found a statistically significant correlation between leadership diversity at large companies, in terms of gender and ethnicity, and those companies’ financial results as measured by operating margin. The new paper, by Jeremiah Green of Texas A&M and John Hand of University of North Carolina, argues that at least on the ethnic diversity side, the studies just don’t hold up.

In the case of the McKinsey report published in 2020, the main study gathered data about diversity on the boards and in the C-suites of more than 1,000 large global companies. The companies were divided into quartiles by diversity, and the operating margins of the most diverse quartile were compared with those of the least diverse quartile over a five-year period. The top quartile were 36 per cent more likely to have operating margins above the median for their industry and region.

Green and Hand make two main objections. First, they tried McKinsey’s statistical approach on S&P 500 companies, and found no significant relationship. Second, they fault McKinsey’s methodology. Because the 2020 McKinsey study used 2018-19 data on companies’ diversity and 2014-18 data on margins, it can’t make claims about the direction of causality. If anything, McKinsey’s work shows that higher margins cause greater diversity. 

I presume, or at least hope, that McKinsey will respond to Green and Hand, and I won’t call a winner in the statistical part of the argument. Nor will I enter into how biases of the two sides might play in here, except to note that (a) the journal that published the Green and Hand paper is published by the Fraser Institute, a Canadian think-tank of a libertarian/conservative flavour, and that (b) McKinsey is a consultancy with a strong incentive to say what its corporate clients want to hear.

My point is more general. There is an implicit argument that stands behind McKinsey’s reports, which runs something like this: a more diverse corporate leadership team brings more viewpoints to bear; bringing more viewpoints to bear renders better decisions; better decisions increase profits; therefore companies with more diverse leadership will have higher profits.  

At a high level of generality, this extended syllogism is valid and sound. Everything we know about collective rationality and good decision making suggests that considering opposing viewpoints carefully is crucial. But the level of generality is precisely the problem here. I think we should not be surprised if the Hand and Green critique holds up, and the reason has nothing to do with the power of diversity. It has to do with whether it is possible to draw a meaningful causal connection between a simple metric of management quality (in this case, ethnic diversity) and a simple metric of corporate profitability (in this case, operating margin) over a shortish time period (in this case, five years). I think that this is not possible for a number of reasons, including:

  • It is almost certainly not enough time. Important decisions made by corporate leadership tend to play out over very long periods. I’d want to see comparisons of leadership today to financial performance a decade hence. 

  • A single financial measure is not nearly enough, and operating margins are a particularly bad choice. What I need to know about a company to assess its profitability is how much money it can make from the capital invested in it, and how effectively the money produced can be reinvested in the future growth of the company. Operating margin measures neither of these things. Information about return on capital and free cash flow growth are both required, just for starters.

  • As Ethan argued to me, it is not clear how much increasing the ethnic diversity of a company’s leadership will increase diversity of opinion within that leadership. The kind of people who can leap through the many hoops required to sit on a board of a given kind of company might be so alike in other relevant respects (educational, professional or personal) that ethnic diversity does not matter much.

I am not arguing that diversity in leadership is not valuable, or even that it cannot be shown to be valuable. The point is just that McKinsey is almost certainly going about it the wrong way. 

One good read

The necktie comeback.

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