December was a solid month for American automakers. General Motors Company (GM) had its best December sales month since 2007, with sales up 19.3% over last year. Full-year sales were up a respectable 5.3%. Ford Motor Company (F) had its best December since 2005, though its full-year growth numbers were actually down slightly due to, among other things, retooling to make way for its new aluminum-body F-150.
Even better, after years of haggling, Americans are paying up for their cars again. December had the highest average transaction prices on record, according to Kelley Blue Book, at $34,367.
So, what’s the story here? Are auto stocks a buy?
I would argue that they are, but not necessarily for the reasons you see in the media.
To start, auto stocks didn’t react particularly well to today’s sales data. GM stock was following the broader market lower, and Ford stock was down by some 3% halfway through the trading day. Wall Street doesn’t seem to be buying the argument that lower gas prices will automatically mean a sustained run in strong auto sales.
I agree. Consumer behavior doesn’t change on a dime, and in any event wage growth has been sluggish since 2008, roughly keeping pace with inflation (see chart). The average American is in better financial health than they were, say, five years ago. But they’re not exactly in great shape.
Furthermore, Americans — and particularly younger Americans — drive less than they used to and are more likely to share rides or use public transportation.
So, if I’m somewhat down on the macro picture for the auto industry … why am I bullish on auto stocks?
I’ll give you three reasons: valuation, dividends, and guru purchases.
Auto Stocks Have a Lot to Love
Let’s start with valuation. In an overpriced U.S. stock market, auto stocks are one of the last subsectors where you can find real bargains. GM stock trades for just 8 times expected 2015 earnings. That’s half the forward P/E of the S&P 500. Likewise, Ford stock trades for just 9 times expected 2015 earnings.
Slicing the numbers a little differently, GM stock and Ford stock trade for 0.36 times sales and 0.41 times sales, respectively. The S&P 500 trades for 1.8 times sales.
Furthermore, after bankruptcy wiped most of its debts clean, GM has the healthiest balance sheet it has had in recent memory. Nearly half of GM’s market cap is cash in the bank. And while Ford has more debt on its books than GM, about 40% of its market cap is sitting in cash.
To be fair, auto stocks should trade at a discount to the broader market. Their earnings are more cyclical, and they operated in a brutally competitive industry. All the same, that’s a pretty massive discount.
Now, let’s take a look at dividends. At 3.5%, GM stock boasts one of the highest dividend yields among major American companies. At 58%, its payout ratio is very reasonably low, and I would argue that this number is actually inflated due to GM’s expensive recalls that dented earnings in 2014. GM’s current $1.20 dividend represents a 46% payout of consensus 2015 earnings estimates of $2.62. If GM’s sales are anything short of disastrous in 2015, there is plenty of room for dividend growth.
The same goes for Ford stock. Ford’s 3.4% dividend yield is very competitive in today’s low-rate environment, and its 31% payout ratio leaves a lot of room for dividend growth.
Gurus Love Auto Stocks
Finally, I like to know who else is in a trade before I get into it. And at least in the case of GM stock, we’re in good company. Marty Whitman, David Tepper, Warren Buffett, Jeremy Grantham and Joel Greenblatt have all initiated or added to their positions in GM stock over the past quarter.
Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he was long GM. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.
