When we compare auto companies, we usually discuss which produces the best models along with the best quality. Many people have said that General Motors has had the best quality and models for decades. In this article however, we are not going to compare the quality of the products they produced, but rather, we will dig into the financial performances of three companies and determine the results of their operating decisions. We will not just be analyzing one year of financial records, but the five periods of historical financial data of each of these companies. By doing this, we are considering the past performances of each company. The companies are General Motors (GM), Toyota Motor Company (TM) and Honda Motor Company (HMC).
Today we will answer the question as to which of these three companies, with their long histories, is considered financially healthy and profitable? Are you planning to make an investment but cannot decide which of these three to choose from? This, then, is the right article for you.
Several valuations and spreadsheets were prepared to give us the answer to our question. Which automaker's operational management and strategy has provided the best financial results from among the three car makers? It's now show time. Come and join me.
Deep Finance Expertise
The investment valuation on General Motors, Toyota Motor and Honda Motor, will be based on the Pricing Model, which is prepared in a very simple and easy way for business valuation purposes. This valuation adopts the investment style of Benjamin Graham, the father of value investing.
My basis of valuation is the company's last five years of financial records - the balance sheet, income statement and cash flow statement. In my valuations, first I will calculate the discounted cash flow, enterprise value and the margin of safety. The relative method was considered as well. Now, let us walk step by step.
1. Discounted Cash Flow Analysis
Today, I am going to share with you the discounted cash flow analysis, which is based upon the five-year historical financial data of GM, TM and HMC. This will assist us to arrive at the projected cash flows. The discounted cash flow is one way to decide if the investment is worthwhile. It is the expected cash that a company can generate from the goods and services it offers. It does not predict the future, but it uses the historical data to project a future financial picture so that readers may understand the parameters that are not easily understood without using a spreadsheet. The table below is the summary I gathered from the spreadsheet.
In the calculation of the present and future value, the capitalization rate that was used was 15%, while for the return on investment [ROI], the average rate was used as well as the price to earnings ratio. The rate used was the average ROI less the average rate of dividends paid.
Furthermore, the computed present value of the equity of GM, TM and HMC was $25.33, $672 and $25.03 per share at a total value of $42.4 million, $1.0 billion and $45 million, respectively, at a rate of 117.54, 2.68 and 10.48%, respectively.
The future value is equal to the present value and this means having a choice of taking the amount of the present value today or to wait for the 5 time periods to have the future value. If you take the present value today, you will have a chance to reinvest the money at the same rate with the equal time periods and will end up having more than the present value.
Furthermore, let us see what's up with their net incomes. The present values of the net income were $555 million, $19 million and $4.7 million for GM, TM and HMC, respectively. In addition, the fifth year income was $1.1 billion, $38 and $9 million at $666.85, $24.46 and $5.21 per share for GM, TM and HMC, respectively.
2. The Enterprise Value Approach
The enterprise value is the present value of the entire company. It measures the value of the productive assets that produced its product or services, and both the equity capital (market capitalization) and debt capital. Market capitalization is the total value of the company's equity shares. In essence, it is a company's theoretical takeover price because the buyer would have to buy all of the stock and pay off the existing debt, pocketing any remaining cash. This gives the buyer solid ground for making an offer.
Going forward, let us walk through the table below as a summary for the calculation of the enterprise value:
The spreadsheet shows that the market capitalization for GM was erratic in its movement, trending at an average rate of 6% from 2010. TM was stable at a $132 billion average, while HMC's market capitalization had increased by 82% from 2008.
The market capitalization to date, May 9, 2013 was $43.5 bil, $189.5 bil and $73.2 bil at a market price of $31.65, $119.7 and $40.6 for GM, TM and HMC, respectively. Moreover, the takeover price for each entire company was $32.7, $280 and $102 billion at $19.55, $179.58 and $56.66 per share, for GM, TM and HMC, respectively.
Furthermore, the total debt of GM was lesser than the cash and cash equivalent, so therefore, buying the entire business of GM, the buyer will be paying 100% of its equity. While TM and HMC has greater debt than its cash, thus the takeover price was greater than the market value, the investor would be paying 59% of equity plus 41% of TM's debt and 66% equity plus 34% debt of HMC, respectively.
3. The Net Current Asset Value Approach
Benjamin Graham's Net Current Asset Value [NCAV] method is well known in the value investing community. Graham was looking for firms trading so cheaply that there was little danger of the stock prices falling further. The object of this method is to identify stocks trading at a discount to the company's Net Current Asset Value per Share, specifically at two-thirds or 66% of net current asset value.
The formula for the net current asset value was: NCAV = Current Assets - Current Liabilities.
The table shows that the stock price was overvalued for the three auto companies because the market price was greater than the 66% ratio. It further indicates that the stocks were trading above the liquidation value of the companies. Therefore, the stocks have not passed the stock test of Benjamin Graham.
4. Benjamin Graham's Margin of Safety
The Margin of Safety is the difference between a company's value and its price. Value investing is based upon the assumption that two values are attached to all companies - the market price and a company's business value, or true value. Graham called it the intrinsic value. Value investing is buying with a sufficient margin of safety.
The question is, however, how large of a margin of safety is needed to be considered sufficient? Graham considers buying when the market price is considerably lower, a minimum of 40%, than the real or true value of the stock.
Let us find out the average margin of safety for GM, TM and HMC. Remember the historical data that was gathered for each company as we take into consideration the prior period's performances.
The margin of safety indicates that there was a sufficient margin of safety for GM. However, neither TM nor HMC has a sufficient margin of safety because the results show less than the requirement of Benjamin Graham of at least 40% below the true value of the stock. Now, what is the true value of the stock? Graham called it the intrinsic value.
Going forward, let me show you the formula for the intrinsic or true value of the stock, as it factors into the calculations for the margin of safety.
The formula for the intrinsic value is:
Intrinsic Value = EPS * (9 + 2G)
The explanation of the calculation of intrinsic value is as follows:
EPS -- the company's last 12-month earnings per share;
G -- the company's long-term (five years) sustainable growth estimate;
9 -- the constant which represents the appropriate P/E ratio for a no-growth company as proposed by Graham (Graham proposed an 8.5, but I changed it to 9);
2 -- the average yield of high-grade corporate bonds.
You see, Graham was very intelligent, and before he considers buying a stock, there must be a sufficient margin of safety, and the MOS factors the earnings and the growth of the company. The sustainable growth rate was calculated by factoring the return on equity and the payout ratio. What a critical way of thinking. I really admire this man.
Moving forward, let us do some digging here. I will share with you the table for growth, which summarizes the results of my calculations in the spreadsheets.
First let me explain to you what we mean by the sustainable growth rate and the return on equity. The sustainable growth rate [SGR] shows how fast a company can grow using internally generated assets (not taking on additional debt or equity) while the return on equity shows how many dollars of earnings result from each dollar of equity.
Comparing the three auto companies, GM has a better growth rate and earnings per share than does TM and HMC. However, GM doesn't pay dividends to its shareholders. Its payout ratio was zero percent, and when it comes to net margins, GM has the lowest rate of 0.99%. Furthermore, TM has the higher payout ratio, at 31%, compared to HMC.
5. Relative Valuation Methods
The Relative Valuation Method for valuing a stock is to compare market values of the stock to the fundamentals (earnings, book value, growth multiples, cash flow, and other metrics) of the stock.
The Price to Earnings/Earnings Per Share (P/E*EPS) will determine whether the stock is undervalued or overvalued by multiplying the P/E ratio by the company's relative EPS and then comparing it to the enterprise value per share.
I noticed that the average P/E ratio of HMC was very high at 72.68. While digging into the financial statement, I found out that the net earnings of the company dropped at a rate of 77% from 2008 to 2009. This causes the price-to-earnings ratio to soar very high at the rate of 356% in just one year, 2009, making the stock price undervalued by 214% during that period.
Overall, the P/E*EPS valuation tells us that the stock prices of GM and HMC were undervalued, while the stock price of TM was overvalued. Moreover, the EBITDA/EV was 39, 9 and 11% for GM, TM and HMC, respectively. And the EV/EBITDA tells us that buying each entire business would take 3, 13 and 9 times the cash earnings of GM,TM and HMC, respectively, to recover the costs. In other words, it will take 3, 13 and 9 years to recover the costs of purchasing.
Overall, it indicates that the stock prices of GM and HMC are undervalued, whereas TM's stock price is overvalued. The three companies are financially healthy. GM is really financially stable followed by HMC. In addition, the growth of GM was better and the test of solvency shows that GM is financially healthier compared to TM and HMC. Therefore, I recommend a BUY on the stock of General Motors and a HOLD on the stock of Toyota Motor and Honda Motor.
Summarizing all the above valuations and metrics, I came up with a conclusion:
I believe that the best investment from the selection (GM, TM and HMC) is General Motors.