Investors have recently become very enthusiastic about electric car companies. Thanks to major improvements in battery technology over the past decade, electric cars are now approaching the cost parity of gas-powered internal combustion engines. When you combine that with concerns about global warming and the trend towards ESG investment, the growth prospects for electric cars, which account for only 2.8% of new vehicle sales today, look really bright.
But before you invest in any of the EV companies out there – many of which are now going public to raise money for favorable valuations – Warren Buffett’s 1999 warning about investing in growth industries came to mind. He gave the warning in 1
Remember cars and airlines
Entire electric vehicles are the revolutionary transportation innovation of the early 21st century, just as the internal combustion engine excited investors in the early 20th century. Imagine being an informed investor in the late 1800s and getting an early look at the first cars. No doubt many would have invested in an invention that would surely earn the fortune of early investors.
The same could be said about airlines. Clearly, the plane was to revolutionize travel and change society forever in the future. So it must have been a promising investment too, right?
A “difference between making money and spotting a wonderful industry”
In 1999, Warren Buffett and partner Charlie Munger were asked to potentially invest in Internet communications stocks, which rose sharply following the proliferation of the Internet in the early 1990s. Berkshire had not touched them, meaning Buffett missed out on a market that was booming at the time.
In response, Buffet said:
They know that the two most important industries of the first half of this century in the United States – probably in the world – were the automobile industry and the aerospace industry. Here you had these two discoveries, both in the first decade of the century – essentially in the first decade. And if in 1905 or so you had foreseen what the car would do for the world, let alone this country, or what the plane would do, you might have thought it was a great way to get rich. But very, very few people became rich by being – by driving on the backs of that car industry. And probably even fewer became rich by participating in the aviation industry during that time. I mean, millions of people fly around every day. But the number of people who have made money carrying them around is very limited. And the capital has been lost in the business, the bankruptcies. It’s been a terrible business. It’s been a great industry. So you do not necessarily want to compare the prospects for growth of an industry with the prospects of growth in your own net worth by participating in it.
Why did not many early car or aircraft investments go? There are a number of reasons, including the capital intensity of these companies and fierce competition.
The automotive industry needs to build expensive factories to grow, and airlines need to buy or lease aircraft to serve customers. Both industries also have a history of unionized workforces. These properties each provide high fixed costs.
If demand falls for any reason – whether from an economic downturn or from a competitor stealing customers – these costs remain, leaving airlines with half-full planes or car companies operating factories with less than full capacity . That is why so many airlines and car companies have gone bankrupt over the years.
The EV industry is the same
While electric cars are innovative and beneficial to society, some of these unfavorable business characteristics remain.
That does not mean you should avoid the sector altogether. But if you are invested in any of these companies, you really need to believe that the company has an advantage over competitors through technology, brand power, financial power or management. This edge or competitive moat is necessary to navigate up and down this high fixed cost industry and to protect your investment capital.
This is especially true as a number of manufacturers of electric vehicles are currently in public battle with current executives such as Tesla (NASDAQ: TSLA) – not to mention almost all older car companies that are now turning to electric cars. Whether it is electric or gas powered, the automotive industry is likely to remain intensely competitive for years.
If I had to bet which public EV company could have any kind of moat, it would be Tesla thanks to its fire capital and leading battery technology, which it will update to investors on September 22nd. That said, with its meteoric rise this year, I think Tesla’s valuation has come before itself.
If you think you have really found a competitively advantageous EV company at a reasonable price, then invest in it at all. But if you do, pay attention to Buffett’s warning and enter the investment with open eyes.
As Buffett himself says: Investing is simple, but not easy.