What Warren Buffett Might Say about Tesla’s Q3 Earnings

• Warren Buffett has been somewhat critical of Tesla CEO Elon Musk. Tesla released its third-quarter earnings on Wednesday, which shattered the estimates. The stock rose sharply during trade on Thursday and recouped a large part of its 2019 losses.
• Financial markets gave Tesla’s third-quarter earnings a thumbs up. What would Buffett say about the results?

Tesla (TSLA) released its third-quarter earnings on Wednesday after the markets closed. The company posted a surprise profit in the quarter. Notably, the third quarter was the fifth profitable quarter for Tesla. The earnings were enough to put bears into a coma as the stock rose on Thursday. Read Tesla’s Terrific Q3 Showing Puts Bears, Critics in a Coma for a detailed analysis of the company’s third-quarter earnings call. We’ll explore what Warren Buffett, Berkshire Hathaway’s (BRK-B) (BRK.B) chairman, might think about Tesla’s third-quarter earnings.

Buffett has been somewhat critical of Musk. Notably, Buffett said that “he has room for improvement.” He also bet against Tesla getting into auto insurance. At this year’s shareholder meeting, Buffett expressed doubt that Tesla would succeed in the insurance business. While Tesla had a blowout third quarter, Buffett might not hold similar views.

As a value investor, Buffett has a different perspective on earnings and valuation. A quarter with a good or bad performance doesn’t really bother him. However, there’s one aspect of Tesla’s earnings that Buffett would criticize. The company posted a GAAP net income of $143 million, while the non-GAAP number was $342 million. The non-GAAP earnings exclude stock-based compensation.

In the past, Buffett has been critical of companies that try to exclude stock-based compensation as well as restructuring charges from their earnings. In this year’s annual shareholder letter he said that “managements sometimes assert that their company’s stock-based compensation shouldn’t be counted as an expense.” He also said, “What else could it be – a gift from shareholders?”

While Tesla still posted a net profit even if we account for the stock-based compensation, there’s a wide difference between the adjusted and non-adjusted numbers. However, there are a few aspects of Tesla’s earnings that Buffett might admire. First, Tesla’s gross margins improved on a sequential basis. Second, the company is working towards a sustainable business. Tesla is sitting on record cash that should take care of its capital expenditure in the coming quarters. Also, one of the important takeaways from the earnings call, which markets didn’t harp on, was that Tesla is talking about sustainable profitability.

So far, Tesla critics have criticized the company for its frequent losses. In the third-quarter earnings release, the company talked about sustainable profits in the coming quarters with temporary exemptions. A value investor likes companies with regular and sustainable profits. Buffett prefers to invest in companies that have an economic moat and can deliver returns throughout the business cycle.

However, Berkshire Hathaway’s recent performance hasn’t been reassuring. We’re talking about stock market returns. In the current bull market that started in 2009, Berkshire Hathaway’s returns have lagged the S&P 500 (SPY). Even though Apple (AAPL) has outperformed the S&P 500 by a wide margin, Berkshire Hathaway’s returns have trailed the S&P 500 in 2019. Apple is Berkshire Hathaway’s largest holding. Buffett has praised Apple on several occasions. However, he hasn’t added any Apple shares since the third quarter of 2018. Buffett has been criticized for sitting on too much cash. Read Is Warren Buffett’s Nightmare Scenario Coming True? to learn more.