Why is everyone talking about electric vehicle stocks?

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Stocks of electric vehicles like You’re here (TSLA -3.65% ) have attracted a lot of attention in recent years, and this has got investors thinking seriously about adding stocks in the sector to their portfolios. With that in mind, here’s a look at why EV stocks are on every investor’s lips right now.

The clean energy transition is real

There’s no getting away from it; the world is moving away from traditional fossil fuel technologies and toward green technologies. The transition is real and is changing the way many industries operate. For example, an industrial giant like General Electric saw revenue growth from its once thriving gas turbine business reduced to a low single-digit rate due to the shift in investment to renewables. Investors are now looking to its renewable energy business for future growth.

Image source: Getty Images.

It’s a similar process in the automotive industry, where the transition from internal combustion engines (ICE) to hybrid and electric vehicles (EV) is accelerating. One way to gauge the level of commitment to change is to look at automakers’ capital spending plans. For example, Cognex (CGNX -1.64% ) sells its machine vision technology to automakers.

Its automotive revenues increase when automotive companies spend to expand production lines. On a Cognex earnings call last year, CEO Rob Willett noted that “we’ve seen global automotive activity accelerate faster than expected in recent months and particularly around electric vehicles,” and “Investment is more about electric vehicles, and we’re also seeing bigger capital projects coming.”

The pandemic has encouraged many auto companies to forego investing in ICE production (due to a weak sales environment) and accelerate investment in electric vehicle technology. Indeed, traditional players like Ford ( F -0.19% ) are moving forward with their investment plans for electric vehicles. Volvo plans to be an all-electric car company by 2030, Ford will only offer electric cars in Europe by 2030 and Volkswagen aims to increase the share of its all-electric vehicles to more than 70% by 2030.

The future of the automotive industry is clear, and it is electric vehicles.

A couple in a car.

Image source: Getty Images.

Government support and regulation

The shift to electric vehicles is not just coming from the private sector; it is actively promoted and invested in by governments around the world. For example, the current US administration has set a goal that 50% of vehicles sold will be electric vehicles by 2030.

To achieve this ambitious goal, the United States will need to invest in charging networks, and the current administration plans to facilitate multi-billion dollar investments in charging networks. In addition, the administration is supporting $7 billion in funding “to accelerate innovations and facilities along the battery supply chain, from refining, processing and manufacturing of battery materials to manufacture of the battery, including components, to recycling and reuse of the battery,” according to the White House.

Governments are aggressively investing in an EV future, which is seen as supporting an environment where EV businesses can thrive.

Investors flock to the sector

It’s a subtle argument but bear with me. One of the reasons EVs are so well-known is that industry fundamentals are improving because investors are flocking to the sector. This argument is based on Soros’ theory of reflexivity and works a bit like that. Investors are overwhelmingly buying into the electric vehicle story. You can see it in the relative valuations between electric vehicle company Tesla and traditional automakers like Ford and General Engines.

A standard valuation method is an enterprise value (market capitalization plus net debt) over earnings before interest, taxes, depreciation and amortization (EBITDA). As you can see below, investors are willing to pay sky-high valuations for an EV-related stock like Tesla.

TSLA EV to EBITDA chart

The data source: Y-Charts.

The high valuation relieves the operational pressure of the company. It also facilitates the raising of capital to finance investments. Likewise, Tesla can attract and retain top talent because stock options have proven to be lucrative. The result is a positive feedback loop through which Tesla’s products improve, as do its fundamentals, as well as the perception of the action. There you go, the loop starts again.

Likewise, investor enthusiasm for electric vehicles is encouraging investment in the industry and increasing the adoption of electric vehicle technology. Of course, the increasing adoption of EV technology (electric cars, charging, etc.) means improving fundamentals for EV companies – the positive feedback loop.

A future EV

A combination of the clean energy transition, government support and positive fundamental-enhancing investor sentiment combine to make the sector attractive to investors. While Tesla and others seem overvalued relative to its current business, there are still plenty of other ways to invest in the electric vehicle sector.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.

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