Don't Listen to Bears, Buy US Auto Stocks

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

The auto collapse appears to have scarred many investors. However, past financial woes don't imply everything about the future. Ford and GM still have attractive brands for consumers and are well positioned to recover against struggling Asian competitors. With multiples already so low, I believe the risk is more than offset by reward and encourage investments in both companies. Please allow me to explain.

Ford (NYSE: F) Still Terrifically Undervalued

If there were ever a turnaround play to back, the US auto market is it right now. Ford and General Motors only trade at 6.8x and 6.2x forward earnings, respectively, despite impressive brand names. While they may have lost their luster after the auto industry's collapse, US consumers don't care about that--they care about quality, reliability, and aesthetics; all of which Ford and GM have delivered.

From a fundamental perspective, both companies are well positioned for a full recovery. While Ford has seen free cash flow drop from $8.5 billion for the TTM ending 2Q 2010 to only $5 billion two years later, $5 billion (which, mind you, is the lowest it has been since the 2Q 2009 turnaround) is still at a 13% yield against market cap. And positive secular trends in lighter weight vehicles gives the producer considerable promise going forward. Ditto for GM, which has received rewards from the Energy Department for its efforts…to say nothing about (*cough*) the government bailout.

Meanwhile, foreign competitor Toyota (NYSE: TM)  has struggled under product recalls and political risks. Japan and China are currently arguing over land claims, and it is likely that Japan could be temporarily left to dry by its Asian peer. And while international performance has struggled due to problems in Europe, Ford continues to perform well domestically. I believe the strong domestic performance is an indication that the brand is still a top name and carries a tremendous amount of goodwill barring macro depressions.

In addition, the company is equipped with strong management that is committed to returning free cash flow to shareholders. This is especially true given that the company at least offers a dividend yield, while GM (which was injected with billions upon billions of cash from the government) does not. It is this kind of support that will enable Ford to ride the lows and gravitate towards higher multiples.

General Motors (NYSE: GM) Also Worthy Of A "Buy"

Well-known investor David Einhorn recently opened a long position in GM. His fund is now the largest shareholder in the company, which will help limit the downside for a few reasons. First, Einhorn's reputation is for being primarily a short seller and a balance sheet wonk. There's a lot to analyze in GM, but that one of the most famous short sellers would take a long position in your company is a pretty strong indication that the bears have it all wrong.Although you should never put your stock into what one person think, it's important to weigh how other people (ie. the market) may react.

Second, it wouldn't be all that surprising that Einhorn buys on the dips, given his history of taking activist positions in undervalued companies. If he believed the stock was undervalued at $12, he probably believes its undervalued at $10 too!

What concerns me, however, is the company's association with government handouts. Robert Ferguson was recently elected Vice President of global Cadillac, but Ferguson's resumé is very short on auto work. In reality, he is from the government and has been a lobbyist for GM over the last 2 years. If GM continues to suggest that its future lies in getting cozy with the US government, shareholders are likely to move towards firms that can carry their own weight, like Ford. That being said, over the last 3 months, shares of GM have risen 24.6%, which is more than 1,500 bps greater than what was achieved by Ford.

I am confident that the company's future stock return looks bright. For one, costs have fallen dramatically over the last few years and the pension fund, once a problem, has become workable. Moreover, net operating loss carry forwards will shelter corporate taxes during the full recovery in a way that the market has failed to account for during the depressed macro period. Forecasts for 11.1% annual EPS growth over the next 5 years are not optimistic enough in light of these trajectories. Accordingly, I recommend buying.

Interested in Additional Analysis?

Ford has been performing incredibly well as a company over the past few years -- it's making good vehicles, is consistently profitable, recently reinstated its dividend, and has done a remarkable job paying down its debt. But Ford’s stock seems stuck in neutral. Does this create an incredible buying opportunity, or are there hidden risks with the stock that investors need to know about? To answer that, one of The Motley Fool’s top equity analysts has compiled a premium research report with in-depth analysis on whether Ford is a buy right now, and why. Simply click here to get instant access to this premium report.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend, Apple, and Google. 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.

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