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By Ahmed Ishtiaq

Ford Motors (NYSE:F) has shown a remarkable rise over the past six months. The stock has gained almost 37%, and I expect the company to continue its steady rise. North American operations of the company are showing incredible growth, and the company is finally coming out of the slump caused by the financial meltdown of 2008. The U.S. economy has started showing signs of recovery with a positive impact on the auto industry of the country as well. The improving economy should enable the company increase its revenues over the next year.

As of the time of writing this article, Ford stock was trading at around $13, with a 52-week range of $8.82 - $14.30. It has a market cap of about $49.64 billion. The trailing twelve-month P/E ratio of 3.0 is below the forward P/E ratio of 7.3. P/B, P/S, and P/CF ratios stand at 2.6, 0.4, and 5.7, respectively. The operating margin is 4.3% while the net profit margin is 13.4%. The company has a high debt load, with a debt/equity ratio of 3.8.

Ford Motors has a 4-star rating from Morningstar. Out of ten analysts covering the stock, three have a buy recommendation and four have hold recommendations. On the other hand, most of the analysts have market outperform rating. Average five-year annualized growth forecast estimate is 5.81%.

We can estimate Ford's fair value using discounted earnings plus equity model as follows.

Discounted Earnings plus Equity Model

This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:

V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5+ Disposal Value

V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]

The earnings after the last period act as a perpetuity that creates regular earnings:

Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r

While this formula might look scary for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my estimates. You can set these parameters as you wish, according to your own diligence.

Valuation

Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of TTM EPS along with the mean EPS estimate for the next year. The average EPS for ConocoPhillips is $1.37.

While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 5.81%. Book value per share is $4.95.

Fair Value Estimator

V0

E0

$1.37

V1

E0 (1+g)/(1+r)

$1.31

V2

E0((1+g)/(1+r))2

$1.24

V3

E0((1+g)/(1+r))3

$1.19

V4

E0((1+g)/(1+r))4

$1.13

V5

E0((1+g)/(1+r))5

$1.08

D

E0(1+g)5/[r(1+r)5]

$9.80

BV

Equals

$4.95

Fair Value Range

Lower Boundary

$17.12

Upper Boundary

$22.07

Potential

69.52%

(You can download FED+ Fair Value Estimator, here.)

I decided to add the book value per share, so we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Ford is between $17.12 and $22.07 per share. At a price of about $13, Ford is trading below the lower boundary of its fair value range. The stock still has up to 70% upside potential to reach its fair value maximum.

In my opinion, Ford has done all the hard work, and now it is the time to reap the benefits of that hard work. After the fall in 2008, the company realized that it needed a change in strategy to compete with companies like Toyota Motor Corp. (NYSE:TM) and General Motors (NYSE:GM). The company introduced "Ford One" plan and completely reorganized its operations. As a result of a change in the strategy, the company has been able to achieve operational efficiency. An increase in operational efficiency has led to an increase in margins. I believe Ford is well-positioned to compete in this dynamic market with the help of its new strategy and focus on smaller more efficient vehicles.

Summary

The U.S. economy is recovering albeit at a slower pace, and the Automobiles sector is at the forefront of this economic recovery. As a result, Ford Motors will be the direct beneficiary of better economic conditions. At the moment, demand for new cars is on the rise in North America. According to different sources, there will be an increase of almost 6.6% in new vehicles bought by Americans during 2013. I believe there is room for Ford to grow revenues and margins. According to our model, there is still substantial upside potential in Ford, and we believe it can prove to be an attractive long-term investment.

Source: Ford Has Substantial Upside Potential