Stocks to sell

Nio Stock Still Has a Great Story and Valuation Issues

There are two figures that highlight the case for and against Nio (NYSE:NIO) stock.

Source: Sundry Photography /

The bull case is strengthened by the fact that NIO stock has pulled back 43% from its January highs. Obviously, that fact alone doesn’t make the shares worth buying.

The massive rally of electric-vehicle stocks that began in November clearly went too far. Nio benefited from optimism about the EV sector, roughly doubling over a nearly four-month stretch. A pullback of some kind probably was necessary.

Still, Nio is much cheaper than it was. And it’s fair to point out that for more than a decade, sharp declines of quality growth stocks have almost always created buying opportunities. After posting impressive results over the past few quarters, NIO is starting to look like a quality growth stock.

There’s another number worth noting, however: $61 billion. That’s the market capitalization of  Nio even after its recent selloff. It’s an absolutely enormous number that’s not far below the combined market caps of Ford Motor Company (NYSE:F) and Stellantis (NYSE:STLA) (the latter company was created by the merger of Fiat Chrysler and Europe’s PSA Group). So the market capitalization of Nio stock might very well be excessive.

A Look at Valuation

NIO stock trades at almost 12 times analysts’ average 2021 revenue estimate.

In this market, that multiple perhaps doesn’t sound all that high. But bear in mind that the stocks that are valued at 20 times their revenue almost without exception are tech firms. Software companies, for example, might have gross margins of 80% or higher.

Nio had gross margins of just 19.5% in the first quarter. And while that figure hasn’t necessarily peaked, the company’s management did say on its first-quarter earnings call that its gross margins would only rise to a limited extent in the near-term. Over the long-term, its gross margins will likely peak in the high-20s percentage levels in even a best-case scenario.

Auto manufacturing — yes, even electric auto manufacturing — simply isn’t all that profitable. And yet the current Nio’s stock price still seems to price in an awful lot of success.

Given the risks posed by the shares at this point, anyone owning NIO stock probably is looking for significant gains. Let’s use annualized returns of 12%, which over a decade would cause the stock to slightly more than triple.

To meet that threshold, Nio in 2031 must have a market capitalization of $180 billion. That, in turn, probably requires net income of at least $4 billion in  that year. Given the auto industry’s profit margins, Nio needs something like $35 billion of revenue to hit that figure. That’s in the range of 1% market share worldwide, based on industry projections.

The Case for NIO Stock

Let’s be fair; Nio can get there. A 1% share of the global market is a bigger number than it sounds. But at the same time, China has roughly 18% of the world’s population. And a steadily growing portion of that population will be able to afford Nio’s vehicles, particularly if the company starts making cheaper EVs.

And while a $180 billion market capitalization sounds enormous, EV companies are getting big valuations. Most notably, Tesla (NASDAQ:TSLA) is still valued at over $600 billion. Those who invested in that stock no doubt are expecting a valuation of at least $1 trillion by 2031.

Finally, there’s one simple retort to Nio bears, even after the pullback of EV names over the past couple of months. Specifically, focusing on valuation alone has been a good way to miss out on big gains by growth stocks. Tesla, of course, is a perfect example.

Personally, I’m sympathetic to the case for NIO stock at this point. The stock’s chart, which shows that the shares have been getting support around their current levels recently, suggests I’m not alone.

Yet I can’t quite get bullish on Nio. China has a huge EV market, but it’s also massively competitive already, with Tesla, XPeng (NYSE:XPEV), Li Auto (NASDAQ:LI) and state-owned manufacturers looking to take their own pieces of the pie.

And while the EV market will grow over time, China is further along than most of the world, as. 10% of its automobiles are already EVs, according to Nio.

In that context, the pullback of Nio stock looks like a needed correction rather than an opportunity. But I’ll admit that I’ve been wrong on NIO before. Reasonable investors can believe that I’m wrong again.

On the date of publication, Vince Martin did not have (either directly or indirectly) any positions in the securities mentioned in this article.