Investing In Japanese Automakers: Eye On Honda

| About: Honda Motor (HMC)

Ahead of the international auto show, which kicks off this week, Detroit was reminded again that it is losing ground to foreign competition, particularly from Japan. The rivalry extends to the Reuters Select stock screens, where Japanese companies recently accounted for half of the opportunities in the automotive sector. Among the standouts was Honda Motor Co., Ltd. (NYSE:HMC).

Both General Motors Corp. (NYSE:GM) and Ford Motor Co. (NYSE:F) are working through restructuring plans. But these giants continue to struggle in the face of international competition: Japan's Toyota Motor Corp. (NYSE:TM) is poised to overtake GM as the world's biggest automaker this year, and Honda continues to enjoy brisk sales in the U.S. market.

The screens are taking notice, too. In total, four out of the 22 companies in the car and truck manufacturers industry highlighted by the Reuters screens were Japanese, including Toyota and Honda. (Click here for an Excel sheet comparing these four companies.)

auto industry chart 1

We last highlighted Toyota on Dec. 21 when it appeared on the screens for Rising Expectations and Lesser Known Stocks. At that time, Honda also registered on the stock screens, landing on the screen for Industry Leaders. As indicated in the table above, these stocks continue to appear on these screens. The one change, though, is that Honda now also appears on the Consensus Choices screen.

The Consensus Choices screen is designed to highlight companies that analysts seem to hold in relatively high regard. Using a rating system that ranges from a buy recommendation receiving a score of 1.00 to a sell recommendation warranting a score of 5.00, the filtering process begins by sorting for companies that have an average rating of 1.75 or lower.

While that restriction works relatively well to highlight companies that have received an affirmative nod from the analysts who follow them, it doesn't tell us about how analyst attitude toward the stock has changed. After all, we don't necessarily want a stock that, at this point in time, might still have a favorable rating but is in a trend of downgrades. Instead, we want stocks that analysts have been upgrading. To make it onto the screen a company's average rating must be less than where it stood four weeks ago. Further, the figure from four weeks back must be equal to or lower than its reading from 13 weeks ago.

As indicated below, not only have analysts turned more favorable on Honda in recent weeks, but all the analysts providing information to Reuters rank it a buy.


The screen also takes into consideration the stock's valuation, weighing the current stock price against expected future earnings and earnings growth through the PEG ratio. The PEG ratio is the relationship between the current stock price divided by expected earnings per share [EPS], or the forward P/E, relative to the long-term expected EPS growth rate. Generally, more-conservative value investors focus on companies with PEG ratios that are below 1.00. Since we aren't looking for bargain-basement prices but just stocks that are, at worst, reasonably priced, the screen sets the upper limit at 2.00.

Based on the current price of about $40 for a Honda American Depositary Receipt [ADR] and expected earnings of $2.25 for fiscal year ending March 2007, the forward P/E is about 17.8. Given the expected earnings of $2.58 for fiscal year 2008, the forward P/E is roughly 15.5. Only one analyst provides an estimate for long-term EPS growth: 8.9 percent. Dividing the forward P/E ratios by this expected growth rate yields PEG ratios that come in just under the wire.

The Industry Leaders screen also takes into consideration valuation, but it looks at the stock's price tag relative to trailing 12-month [TTM] EPS. Here, too, we aren't looking for cheap stocks, but shares that are reasonably valued. Thus, the screen allows a stock to have a P/E that is above its industry average, but caps the premium at 10 percent. On this basis, Honda is priced at about an 8-percent premium.

Honda valuation ratios

To rank among the Industry Leaders, a company must also post industry-leading revenue and EPS growth rates over the last five years. Its five-year EPS growth rate must also be faster than the company's revenue growth rate during the same time frame. Honda easily sails over this hurdle.

Honda growth rates

Industry Leader companies must also be more efficient than their industry peers. To that end, a company's TTM net profit margin must be at least 10 percent wider than the industry norm. By many different measures, Honda's profit margins eclipse the industry averages in the TTM span and over the last five years, as shown below.

Honda profitability ratios

Some of the factors that have helped Honda land on the Industry Leaders screen may shed some light on why analysts regard it high enough that it also appears on the Consensus Choices screen. While investing in Japanese car and truck manufacturer ADRs may seem appealing given some of these dynamics, there are some caveats. For example, ADRs are a good way for U.S. investors to gain exposure to foreign companies, but, as baskets of foreign stocks, they expose investors to the same types of political, economic, and currency risks that go along with international investing.

Disclosure: At the time of publication, Erik Dellith did not directly own shares of any company mentioned in this article. He may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by