There is an interesting phenomenon going on with Ford (NYSE:F) and other automakers. Investors are applying the opposite valuation of what they should, given where we are in the economic cycle. This isn't unique to automakers, in fact, and I think is representative of how general market perceptions are not following historical trends. Fears of a return to 2008 seem to be persisting
David Einhorn said it well in his most recent quarterly letter discussing his new investment in GM (NYSE:GM):
GM is being priced by the market as a cyclical company trading at less than 6x this year's earnings. While some may see it as normal to value cyclicals at low multiples of peak earnings, we believe that 2011 is not a peak and, in fact, is below mid-cycle.
Ford is trading at under 7 times earnings, and doesn't have the government ownership overhang that GM does. Of course, with GM's pre-packaged bankruptcy came a clean break from its pension and healthcare liabilities -- a luxury Ford doesn't have. What Ford does have, though, in addition to freedom from government ownership and the stigma rightfully attached by that, is better management and a better near term catalyst. For Ford, a dividend is coming soon, and with that will come a new class of owners, which will drive the stock price up.
That dividend discussion is for another article. The primary reason to own Ford now is that it is trading as if it's at peak earnings, but it is not. Generally the time to buy cyclicals is when their multiples are high. This is because they are coming out of a bottom where earnings are depressed, and the market has not yet anticipated the jump in profits to come. The time to sell is when the multiples are low, because earnings are at their peak, and the market has not yet anticipated their drop.
Ford and GM are now trading at low multiples, despite trough earnings. This simply isn't right. The run rate for North American auto sales last month was under 13 million per year; normal would be closer to 15 or 16 million, and peak would certainly be above that. We're coming off recession lows, and we may not hit peak sales for some time, but the monthly run rate has been increasing this year, and there has been no indication it will drop off, despite negative economic headlines. However, even if the recovery stalls, that seems to be already baked into the share price.
It's rare you get such a clear margin of safety staring you in the face. Multiples should be dramatically higher than they currently are. Couple that with increased earnings over the next few years, and investors will look back at Ford's stock under $11 today and regret not having bought it.