Second only to Do you think we've hit a bottom?, the most common question I hear from folks is: Where should I be (or are you) putting money these days? It is usually followed up with some statement about how terrible the stock market is and/or how impossible real estate is right now.
Then, I get hit with the request for affirmation—the old, XYZ company is pretty beat up. What do you think? Most recently, the request has been about General Motors and Ford. Before that, Bank of America, AIG, and Fannie/Freddie.
Why do I call this a "request for affirmation"? Most of the time, the people asking have been decimated in the markets and are feeling the need or desire to make it back quick. They want to take a gamble on a beat down company, not because the business is sound, but because what was a $20 or $50 or $80 stock is now a $2 or $3 stock.
So...coming back from a long (and long overdue) break, let's get back to the basics. And to do that, we'll pick on General Motors again.
Some Stock Are Cheap Right Now, Some Are Not
At any given time, in any given market environment, the enterprising investor can usually find a bargain. Though stocks in the aggregate move with the markets (because they are the markets), individual stocks move independent of the markets.
The markets are a force on all stocks. When the markets are down 30%, 40%, or more, long-term upward movements in a stock price are usually held back, not reaching their full potential in the down market. When the markets are flying high, overpriced, mediocre, and bad companies can fly high with them.
We've seen a few examples of this over the past seventeen months. One that is in the news and on peoples' lips is General Motors—a company we've discussed here a few times in the past. Here's the chart since F Wall Street started on June 25, 2007:
On the next chart, I've highlighted in green the times and prices where I felt GM was a bad business and not worth owning:
Is General Motors (GM) Cheap?
General Motors is down; but down and cheap are two different things. Over the past forty seven years—a sufficient time to judge investment results—General Motors has returned roughly 1.8% a year to investors. Now, you may think that judging performance at today's prices is unfair; so, assuming GM was $15 a share, it would have returned 4.4% a year to investors over the past forty seven years.
During that time, General Motors had a CROIC of roughly 4% or so; thus, investors purchasing General Motors at fair prices over the past forty seven years should not have expected much more than a 4% or so return during that time.
So, is it cheap? I can't tell you that—there is too much uncertainty. If they receive and continue to receive gobs of money from the government and ultimately survive this mess, it won't change the fact that GM—and pretty much any auto maker—is a mediocre or bad business (from a capitalist perspective).
Now, the question...
Do You Think It's Cheap?
Long-time readers know that I shied away from financials for a long-time, even though there is blood in the streets. Why? They are outside my sphere of confidence and competence. Sure, I'll miss some high fliers when the economy is better three...five...ten years from now; but, I don't have to be in those high fliers. There will always be blood in the streets somewhere.
General Motors at $4 a share. Cheap? Ugly? Don't buy it just because it's down. Don't buy it just because Wall Street is talking about how "cheap" the price is. (The table below shows how "wise" Wall Street has been on General Motors for the past two years or so.)
Rip open the annual and quarterly reports, and decide for yourself. Looking at the latest quarterly report, I immediately realized that, if GM were to ever make it out of my "No" pile, it would have to go in my "Too Hard" pile.
We know GM is in a liquidity crisis—a major liquidity crisis. Here's their plan for solving it:
We will continue to identify and develop additional sources of liquidity, including a broad global assessment of our assets for potential sale or monetization. We believe that we can raise significant liquidity from asset sales without negatively affecting our strategic direction. In addition to asset sales, we will also continue to access global capital markets on an opportunistic basis when the global capital markets are available to access on terms which are acceptable.
Be wary of the managers that tell you that they can sell a significant portion of the company's assets without negatively affecting the business. I don't know what GM's "strategic direction" is; but, without assets, I know in what direction it is headed.
If the company has to rely on stock and bond offerings to keep afloat, look out. (That's the "we will also continue to access global capital markets" line.) Just ask the folks over at Amylin.
What are the odds that GM will get any money other than government money? Slim to none, short of a complete takeover. So, a little more thought has to go into this.
In poker, an "out" is a card or series of cards that will give you a winning hand when you are behind. I think GM's outs are long-shots at best:
- Operate under bankruptcy protection.
- Go belly up and liquidate.
- Be taken over.
- Get a life-line from the government and/or some big investor(s) and fix its problems.
The problem with bankruptcy protection (among others) is that it shafts its suppliers and all but forces the other auto makers into bankruptcy protection to be able to compete. Then again, the odds are stacked against GM to compete under bankruptcy protection because it still faces fierce oversees competition in a lowest-price-wins product war for business from customers that, in the aggregate, have little to no brand loyalty.
We'll assume that "belly up and liquidate" is not an option. It may be the only course; but, this would automatically disqualify GM as an investment at today's prices.
General Motors can be taken over by a competitor. But who? US auto makers don't have the means to do so, and foreign auto makers are snatching market share and building and selling vehicles for cheaper. Thus, a GM acquisition would be entirely lopsided in favor of GM, and no intelligent company would make that deal. (I liken it to Bank of America's acquisition of Countrywide. It was entirely lopsided in favor of Countrywide. What the hell was BoA thinking?! A complete waste of shareholder money!)
GM Needs a Plan
So, GM needs a plan to cut expenses and increase liquidity. By now, you probably heard about the private plan debacle at the Washington hearings. Management seems to be more concerned with squeezing the last nickel out of GM than with making the painful sacrifices necessary to turn the company around.
What should be in the GM plan? Once management is dumped, the next step is to take care of excessive expenses. Then, the company needs to shed some inventory. Inventories have been on the rise which means that the company has been burning through cash to build inventories that nobody is buying.
How do you shed inventory? First, GM needs to slow production. Then, they need to firesale the rest before it is firesold in bankruptcy proceedings. How do you firesale inventory? 50% off.
GM has $11.9 billion of "Finished product, including service parts." Sell it. Sell it all, at 50% off. "Oh, but we don't want to take a loss!" Wrong—you have already taken the loss and you continue to take the loss. An inventory firesale serves a number of purposes:
- It raises up to $6 billion in cash;
- It reduces expenses associated with storage, transportation, etc.; and,
- It is brilliant marketing.
The third point is the key. Auto commercials are ineffective and expensive. Thus...pointless, but necessary. A better way to market your product is to put every Tom, Dick, and Jane into a Chevy, Buick, Cadillac, HUMMER, whatever. Everyone is driving them; so, everyone sees them all the time.
And, it forces a greater need for your products. GM makes parts. When you have the lion's share of the market because you gave your cars away, you create massive demand for your parts and service.
But...It's Too Hard
I could go on for hours; but, it all adds up to one thing: GM has very severe problems. I think that they are fixable; but, you need the right management. And GM does not have the right management for the job.
GM is down. It may even be cheap. But, the best I could hope for (note the key word—hope) is to pick up a mediocre business. Hardly a smart move when, in this sort of market, there are so many highly predictable businesses at or near attractive prices.
So, I'll move on.