Goodyear: Why Warren Buffett Would Buy This Company

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Because we are so enamored with companies like Chipotle, Netflix , Panera Bread, Salesforce.com , Starbucks , and Whole Foods – all of which are currently trading at P/E ratios around 30 (plus or minus) – some of the less sexy companies like Goodyear (NASDAQ: GT) fail to show up on our radar.  And that is not a mistake – Goodyear is indeed now trading on NASDAQ instead of the New York Stock Exchange.     

A Business Model that we Understand

Goodyear was incorporated in 1898.  The company has survived for over 100 years because it produces products that its customers need and want.  For those of you who didn't already know, the Company's principal business is the development, manufacture, distribution and sale of tires and related products and services worldwide.

Unlike many of the tech companies that are here one day and gone another, Goodyear has a stable business with predictable demand and significant barriers to entry.  Furthermore, when you purchase shares of Goodyear you become “part owner” of a company whose business you understand.  Owning Goodyear is not like owning Facebook, a company with an unproven business model. 

Goodyear by the Numbers

The chart below compares Goodyear to three other companies – AutoZone (NYSE: AZO), Advance Auto Parts (NYSE: AAP), and Genuine Parts (NYSE: GPC) – across 5 metrics: Revenue per Share, Net Profit Margin Percent, Price to Earnings Ratio, Forward Price to Earnings Ratio, and current Stock Price. 

A number that should leap off the chart is Goodyear’s profit margin – a very low 1.2%.  That is a huge area of opportunity.  If Goodyear can either reduce costs by improving its cost structure or significantly increase its revenues, then we could see Goodyear’s share price pop. 

<table> <tbody> <tr> <td> <p> </p> </td> <td> <p>Goodyear (GT)</p> </td> <td> <p>AutoZone (AZO)</p> </td> <td> <p>Advance (AAP)</p> </td> <td> <p>Genuine (GPC)</p> </td> </tr> <tr> <td> <p>Revenue/Share</p> </td> <td> <p>$82.17</p> </td> <td> <p>$222.80</p> </td> <td> <p>$83.80</p> </td> <td> <p>$82.42</p> </td> </tr> <tr> <td> <p>Net Margin (%)</p> </td> <td> <p>1.2%</p> </td> <td> <p>10.9%</p> </td> <td> <p>6.3%</p> </td> <td> <p>4.8%</p> </td> </tr> <tr> <td> <p>P/E</p> </td> <td> <p>16.4</p> </td> <td> <p>14.8</p> </td> <td> <p>13.4</p> </td> <td> <p>16.2</p> </td> </tr> <tr> <td> <p>Forward P/E</p> </td> <td> <p>5.6</p> </td> <td> <p>11.5</p> </td> <td> <p>12.6</p> </td> <td> <p>14.8</p> </td> </tr> <tr> <td> <p>Price</p> </td> <td> <p>$13.08</p> </td> <td> <p>$358.30</p> </td> <td> <p>$70.27</p> </td> <td> <p>$64.11</p> </td> </tr> </tbody> </table>

What is a fair valuation?

As a rule of thumb, an analyst can never be wrong if she states that a company is “fairly valued” at its current price.  Stating otherwise is more or less equivalent to saying that everyone else is wrong and you are right or that you are smarter than everyone else, especially if you do hedge your position.  Financial analysts tend to shun away from going out on a limb and making a prediction.  The same holds true for many other professions.  Did you ever seek legal advice?  The answer is always “it depends.”    

That is why my position is that in contrast to many of the companies that we are enamored with, many of which seem priced to perfection, Goodyear seems to have several negative expectations already built into its valuation.  The most salient can be extrapolated from Goodyear’s forward P/E ratio (currently a paltry 5.6), which is very low for an established company like Goodyear.  From this data point we can reasonably infer that it doesn’t seem as though too many people really believe that Goodyear is going to deliver against its forecasts.  In other words, Goodyear is currently valued at 16 times earnings, and that valuation would be reasonable if Goodyear were not expected to meaningfully grow its earnings.

3 Reasons to Warren Buffett would buy Goodyear

  1. Expected Return.  A person who thinks like Warren Buffett tends to develop different courses of action, assign probabilities to each of those, and calculate an expected return.  After considering all of the data points for Goodyear, that calculus might look something like this – probability of getting around a 50% return (buy at $12 and sell at $18): 40%; probability of Goodyear being dead money and breaking even or taking a small loss: 10%; and last but not least, the probability of reaping a very modest return of 5-10% merely due to the volatility of the market: 50%.  Multiplying the probabilities by the returns and summing them up gives an expected return of around 25-30%.       
  2. Innovation.  Goodyear was recently named a Thomson Reuters 2012 Top 100 Global Innovator, because it is one of the world’s most innovative companies.  In fact, this is the second year in a row that Goodyear was honored with this award, which according to Reuters is awarded based on a series of patent-related metrics.  According to Chief Technology Officer Joseph Zekoski, whom I agree with, “Whether it’s the innovative tread zones and evolving traction grooves in the Goodyear Assurance Triple Tred All-Season tire or future breakthroughs such as Air Maintenance Technology, Goodyear is leading with innovative products that consumers need and want.” 
  3. Goodyear has products that we use and a business that we all understand.  Goodyear manufactures and sells tires under several other brands in addition to the Goodyear brand such as Dunlop, Kelly, Fulda, Debica, Sava and even under the private-label brands of certain customers. In certain markets Goodyear also retreads truck, aviation and heavy equipment tires, manufactures and sells tread rubber and other tire retreading materials, provides automotive repair services, and manufactures and sells flaps for truck tires and other types of tires.

My Foolish Take

There are several catalysts that could send Goodyear’s stock price up: (1) Goodyear meets analysts' expectations and delivers EPS of around $2.34; (2) Goodyear has 4 profitable quarters in 2013 (something that it hasn’t done in a while); and/or (3) Goodyear beats analysts' expectations in the near future.  If Goodyear can convince potential investors that its cost structure has improved and stabilized, its share price could increase by more than 50% over the next year.  Plus, although largely symbolic, Goodyear’s move to the NASDAQ should provide the company with more visibility and more branding opportunities. 

 

 


RyanPeckyno has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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