Automakers Make for Wise Investments?

By Matthew McMichen - August 9, 2012 | Tickers: F, GM, HMC, TM | 0 Comments

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At a time when uncertainty shrouds the automotive industry, scaring many investors away, there may be some hidden gems to uncover.  And just like the owners of mint condition classics cover their gems and hide them away in climate-controlled garages, only to be uncovered for the most special of occasions, we too only want to uncover our hard-earned wages for solid investments. 

To see if there are any automotive companies worth your consideration, I've provided a brief analysis and comparison of some of the top players in the automotive game, namely General Motors Company (NYSE: GM), Ford Motor Company (NYSE: F), Toyota Motor Corp. (NYSE: TM), and Honda Motor Co. (NYSE: HMC).

To start, we'll take a look at revenue growth and gross margins to see how successful the companies have been at not only increasing revenue, but also at managing the corresponding costs to do so.  As revenue growth and effective cost management (when evaluated on a long-term basis) may be promising indicators of a solid company, these measurements alone are not necessarily indicative of good investments.  Therefore, we'll also evaluate each company's debt-to-equity ratio to see how financially stable they are, and their price-to-earnings (P/E) and price-to-free cash flow (P/FCF) ratios to see how well they're priced. 

*Ratios obtained from Fool.com

A Drive Through the Numbers

When comparing the average revenue growth over the last five years for the above companies, we’re immediately required to pump the brakes.  The only company able to achieve positive results was Toyota, but even its success was underwhelming at best.

Granted, the last five years have been a tremendous challenge to the automotive industry at large (as proven by GM’s Chapter 11 bankruptcy in 2009).  We therefore need to take that into account, as any of the above companies could position itself to gain significantly from an eventual economic recovery if it plays its cards right.  With the highest gross margin and one of the better debt-to-equity ratios, Honda may very well be the company best positioned to do so.   

When comparing the trailing twelve-month P/E ratios, Ford races past the competition, but don’t disregard the fact that it was also one of the worst performers in revenue growth.   Cheap stock valuations are not always indicative of undervalued, must-buy investments.  And as many of Ford’s SUV owners recently discovered, sometimes you get what you pay for.   The next best P/E is GM’s $7.10, however GM has a lot of ground to gain and needs to prove itself as a long-term company before I’d consider investing (lest we forget the 2009 bankruptcy mentioned above).  With P/Es of $37.00 and $22.00 for Toyota and Honda, respectively, the picture only gets darker, as these prices are just too high for such lousy revenue growth.

The same can be said of each company’s P/FCF ratios.  On the surface, GM and Ford both look like great investments with incredibly cheap P/FCFs of $2.10 and $8.40, respectively.  However, the two have also performed the most poorly of the above group over the last five years and therefore warrant their cheap prices.  Toyota and Honda, on the other hand, have negative P/FCF ratios as both companies have negative free cash flow (a product of declining operating cash flows and increasing capital expenditures).  While it’s good that both companies appear to be increasing their capital expenditures in order to grow, the declining cash flow from operations is a huge warning sign, as cash flow is the lifeblood of any successful, long-term business.

Keep the Cover On

While investors could stand to benefit from any of the above companies rebounding in an eventual economic recovery, current numbers may suggest the timing just isn’t right.  In this case, time is our friend, and I’m interested to see what a few years will bring for the automotive industry.  Until then, it may be best to keep the cover on your wallet by investing in other, more stable companies.

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