General Motors' Stock Is Much Cheaper Than You Think

Jul.10.13 | About: General Motors (GM)

About 12 months ago I bought a very large long position in General Motors' common stock (Ticker:GM). After I had done a lot of research I concluded that the stock was an absolute steal at the price it was offered at as it represented a material discount of around 50% to the company's intrinsic value. So I paid $20.62 per share and today, just 1 year later, the stock trades much higher, closing at $34.92 per share on Tuesday and generating around +69% for my portfolio. Many investors who see these high returns in such a short time frame take the view that "this trade is done, make sure you take profits and move on." I couldn't disagree more. I believe there is much more upside to General Motors' common stock and in this article I will show you why GM's stock, despite its recent run-up, is still a bargain security and should still be seriously considered as a long-term investment.

Okay, let's get started. There are three key factors that I will use to show you how cheap GM's stock really is. They are really simple to understand but their consequences are quite dramatic. They are:

1. Earnings Per Share (EPS) In 2013

2. Earnings Per Share Growth (EPS Growth) In 2014 And Beyond

3. Deferred Tax Assets (DTAs)

1. Earnings Per Share In 2013

During the current financial year analysts on average expect GM to earn between $2.90 and $3.30 per share. My own conservative analysis puts the number firmly in the middle of these two, around $3.10 per share. At Tuesday's closing price of $34.92 this then implies a current P/E ratio between 10.6x and 12.0x, depending on how optimistic you want to be for the second half of the year. That may not sound like a bargain at all, and that's where most investors go wrong. To see why these numbers are somewhat misleading let's move on to EPS growth and see what happens.

2. Earnings Per Share Growth (EPS Growth) In 2014 And Beyond

GM's earnings per share are about to grow significantly over the coming years. This is due to a combination of increased global demand for cars (especially in the US), a stabilisation and eventual turn-around of the European business, bigger margins due to consolidation of car architectures plus cost cutting, and crucially the impact of the Series A and B preferred stock conversions that happen at the end of 2013 and 2014. Analysts expect the company to grow EPS from $2.90-3.30 in 2013 to $3.80-4.50 in 2014, on to well above $5.00 per share in 2015 and 2016. If we just look at the 2014 numbers then the current share price implies a 1-year forward P/E ratio between 7.8x and 9.2x. That looks a lot cheaper already, much closer to being classified a bargain. But here comes the real shock: that's not all! The stock is even cheaper than that, and to see why one must look at the company's deferred tax assets.

3. Deferred Tax Assets (DTAs)

A deferred tax asset is an asset on a company's balance sheet that may be used to reduce any subsequent period's income tax expenses. They usually arise from losses in previous financial years, and in GM's case are a leftover from the days before the company's bankruptcy.

The DTAs on GM's balance sheet are huge and Morgan Stanley analysts have calculated that the company's deferred tax assets are worth $8.81 per share using a discount rate of 14.0%. If you take a minute to think about this, then you will quickly realise that what this means is the following: General Motors' stock at $34.92 includes a DTA of $8.81, which in turn means General Motors excluding the DTA is selling for just $26.11 per share.

Now, EPS figures quoted in the company's income statement ignore the DTA (i.e. tax in the income statement is being reported as if GM was paying that tax, even though the company isn't really paying it), so to calculate a correct P/E ratio we must exclude the DTAs in both the EPS figure as well as the price per share figure. So we really should take $26.11 rather than $34.92 to calculate our P/E ratio to really exclude the DTAs fully.

This then leads to the following results: Based on 2013 earnings, the company trades at a current P/E ratio between 7.9x and 9.0x, and based on 2014 earnings estimates the company trades at a 1-year forward P/E ratio between 5.8x and 6.9x.

Now if that's not a bargain, then I don't know what is!

Another way of looking at the same thing is to keep the DTAs included and use $34.92 per share, but then also adjust the EPS figures upwards to include the effect of the DTAs. The P/E ratios obtained are pretty much the same as above, so whichever way you prefer to look at it, you will come to the conclusion that GM's stock is trading at roughly 6-7x 2014 earnings.

I'm pretty sure that this valuation won't stay that low forever and investors would do well to exploit this inefficiency while it lasts. There really aren't many industry leaders with a growth story that sell for that low a multiple!

Disclosure: I am long GM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.