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Automotive Industry

Why Auto Stocks Are Undervalued - Brief Article

Automotive Industries, Sept, 2000 by Maryann Keller

The marketplace is changing -- and with it come numbers investors don't like.

Why is it that automotive companies out-earn many of the so-called high-tech businesses, yet investors value the shares at less than 10 times profits?

We often hear that "Wall Street doesn't love auto stocks." Wrong. Wall Street is a place, and Wall Street doesn't value anything. Investors, like every reader of this column, do. Whether you own stocks directly by buying them through a broker for your portfolio, or indirectly through ownership of mutual funds or in your 401K, it is the collective decisions of investors that determine the price -- and hence, the price/earnings (P/E) ratio -- of every stock. Every one of us wants to get the highest possible return while we minimize our risk.

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Stock prices rise because there are more buyers than sellers. They fall when there are more sellers than buyers. When a company has great growth prospects, investors will accumulate shares and the P/E ratio rises. When they are less confident in the company's prospects, fewer investors buy the shares. And that is reflected in a lower P/E ratio.

Throughout most of the 1990s, auto analysts were positive about the profit outlook and, therefore the capital gains potential, of most auto company shares. But, auto analysts are specialists in only one industry, whereas the individual or professional investor weighs every industry and company and determines how they want to create a portfolio. For you or the portfolio manager, the relevant question may not be whether Ford is more attractive an investment than General Motors. Rather, it is whether Ford is more attractive than General Electric, Cisco, Intel or any other stock or bond.

The key to the underlying valuation of any stock is the perception of predictability of its earnings outlook. Does the company control its market? Is it a leader in its business? Are its margins expanding and does its have long term strategic advantages over its competitors that lock in market share and pricing power? Generally when the answers to the above questions are "yes," the P/E ratio of a company will be high. The closer you get to a "no" to any of these questions, the more likely a stock will be valued on its current profits, because investors have little confidence in the future earning power of the company.

Herein lies the crux of the problem for auto companies. They entered the 1990s with heavy balance-sheet debt, huge pension liabilities and operational problems. They ended the decade with huge cash balances, strong balance sheets and limited, if any pension problems.

The light truck bonanza was unexpected and its duration caught foreign competitors by surprise. As long as they did not have competitive product, the domestic makers earned above average profits on these vehicles. This offset the losses or low margins on cars.

But now the marketplace is changing. Investors are focused on a few numbers which they don't like. Overall domestic market share is down and it's recently been falling in the light truck sector, as new foreign competitors enter the fray. Incentives on light trucks are rising while the industry capacity to produce them will increase by more than a million units over the next few years. And spiraling gasoline prices could cripple demand for the largest and most profitable of these vehicles.

This is not a scenario that gives investors confidence in the earnings predictability of the auto industry.

Had auto companies broadened their earnings from overseas sources and domestic cars, or demonstrated sustainable market share or significant production cost advantage, investors, like you and me, as well as portfolio managers investing your 401K funds, would be buying up these shares.

Have you called your broker and bought auto stocks recently? If not, don't blame Wall Street for low P/E ratios. All of us collectively express our view about a company, or an industry, by what we are willing to pay for its shares.

MARYANN KELLER is president of auto services at Priceline.com.

Automotive Industry

Why Auto Stocks Are Undervalued - Brief Article

Automotive Industries, Sept, 2000 by Maryann Keller

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