Great Valuation, But Investors Are Taking A Chance

Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

General Motors (NYSE: GM), the world’s largest auto manufacturer, has certainly gotten itself into better shape than it was in a few years ago.  Going bankrupt in 2009 may have been the best thing for the company, as it allowed GM to shed a lot of debt and start fresh.  If analysts’ estimates are correct for the future of GM, it may be worth taking a gamble on.

Now, before I get into my reasoning, there is something I should address.  Every time I write anything in favor of buying GM stock, I get comments to the effect of “I will NEVER invest in GM again after what happened to their shareholders!”  I have mixed feelings when it comes to this.  On one hand, I really can’t blame those people for feeling that way.  Anyone who owned shares before the bankruptcy was virtually wiped out.  However, it was no secret that GM’s cars were inferior to their foreign competitors for years, and that the company was drowning in an unrealistic amount of debt. 

Investing in a company like GM was a gamble then, just as it is now, and unfortunately it didn’t pay off.  This is similar to how I have a tough time feeling bad for people who bought 4 houses they couldn’t afford in 2005 because they assumed the values would keep going up and now have a history of foreclosures and destroyed credit.

But, back to the topic at hand.  The “new General Motors” emerged from bankruptcy 16 months after filing.  With the ensuing IPO, the Treasury’s sold part of its stake in the company, and plans to exit its entire stake in the near future. 

As a result of the bankruptcy, GM discontinued several of its underperforming brands such as Saturn and Pontiac, in order to focus on their core products, in addition to the closing of many dealerships.  GM and Ford (NYSE: F) have both done a great job of producing new, innovative cars and trucks that are finally measuring up to the standards of foreign rivals, like Toyota (NYSE: TM).  The U.S. automakers want to see the steady erosion of their market share reversed.  They are certainly on the right track, product-wise. 

Additionally, rising middle-class wealth in countries like China and India are expected to boost global vehicle sales, and all of the automakers should benefit as this unfolds.  While the number of new vehicle sales is expected to be flat in the US, global sales are expected to increase 5% this year.

As far as the financial health of GM goes, check out some of these numbers, which are ten times better than before bankruptcy:  GM has approximately $39 billion in cash on hand, and only $16 billion in total debt.  That’s right; GM has a net cash position of about $23 billion, or over half of its market capitalization of $44.1 billion!  This is offset by the company’s underfunded pension obligations of around $25 billion; however I’ll take it any day over the financial state of the “old General Motors.”

From a valuation perspective, GM seems downright cheap; however this is due to the major perceived risk associated with the company.  GM currently trades for just 8.5 times 2012’s earnings, which are expected to grow by an average of 19.1% for the next three years.  In other words, GM trades for only 5.2 times 2015’s projected earnings and has no net debt!  As stated before, value like this is not without risk.

Ford is also very nicely valued right now, but since the market does not perceive Ford to be as risky as GM, it trades at a slight premium.  Ford earned $1.41 in 2012, so it trades for about 9.3 times earnings.  For those who don’t remember, Ford was in the best financial shape of the “big three” by far during the crisis.

For a rock-solid Japanese automaker, investors have to pay even more of a premium.  Toyota trades for 14.6 times current year earnings, which are expected to rise by about 12% going forward.

Think of choosing an automaker in terms of risk level.  For the most stable play, a long-established foreign automaker like Toyota is most appropriate.  Ford is a little more risky, but has a nice history of responsible management decisions.  While I wouldn’t advocate investing retirement money in the stock, the “new” General Motors could pay off tremendously if they get it right the second time around.

KWMatt82 has no position in any stocks mentioned. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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