GM Is Cheap for a Reason

Let’s face it. General Motors is in terrible shape. It sells an unpopular line of vehicles and is completely captive to its inflexible cost structure. Despite what political pundits would like to suggest, the company’s troubles are not the result of a lack of environmentally friendly products – they are due to the fact that consumers just don’t want to buy their cars. It’s really pretty simple.

Now, having said this, the stock of the company is not inherently a bad investment. For one thing, the company seems to (for elusive reasons) be wholeheartedly supported by US government. This is almost certainly the only reason why the company has not already filed bankruptcy. After all, in the past three years GM has posted cumulative losses equal to twice market cap of the company when the stock was at its peak.

There are a lot of stakeholders in a company as large as GM, but of all of them bankruptcy would hurt the shareholders the most. So there is value to the nonzero probability that the company will somehow avoid bankruptcy and survive as a going concern. (Aside: In the case of a GM bankruptcy, I would say there is an above-average chance that absolute priority would be violated and shareholders would not lose completely, in light of the “too many people have their 401(k)’s invested in GM stock” mantra.)

But GM stock is cheap. Really, really cheap. From its 2007 high, the stock has lost an astounding 96% of its value. So, for the moment, let’s assume the company does not file bankruptcy and that we must rely on the future cash flow production of the company to assign the stock a value. Believe it or not, even the current stock price of $1.69 may be too expensive because this price implies Required Business Performance that is actually greater than most people expect.

At the current price, revenue can decline by only 12% in the upcoming twelve months, and this is assuming a moderate improvement in gross margins. This does not seem likely to happen. In the absence of the unprofitable sales generated in 2007 by heavy discounting and promotion, sales of the company have been steadily declining for several years. In fact, in Q4 of 2008 sales fell 35% versus the same quarter a year earlier. And now the company faces not only its internally generated hardships but also an unforgiving macroeconomy.

For these reasons, even though the stock is basically as cheap as it has ever been, the company still has only a 50% RBP Probability, indicating that it’s pretty much a flip of the coin as to whether it will produce the results need to support an already miserable stock price. There are a lot of cheap stocks in this market. GM is one that is cheap for a reason.