Investors of Ford Motor Company (NYSE:F) have been in for quite a wild ride. During the past 5 years, the stock price has fallen over 80%, risen over 900%, and fallen once again another 50%. With such volatility, it is a high probability that very few investors entrust a significant percentage of their portfolio holdings in Ford. Through this analysis, I will make the argument that future downside could be in store for Ford due to declining profit margins and weakening revenues.
I began my study by examining profit margins. Profit margin is essentially the percentage of revenues that exceed the cost to run the company. While profit margins are greater than 0%, the firm can be considered to be conducting profitable business. If profit margins are less than 0%, the firm is losing more in costs than it is making back through revenues. In the chart below, the past 5 years of Ford's profit margins can be seen.
Let's start by examining 2008-2009. During this time period, profit margins were strongly negative for the first year and a half. The firm was not conducting profitable operations, and any firm which continues operating unprofitably must increase revenues, decrease costs, or eventually expire. Between the years of 2010 and 2012, the company was barely profitable with profit margins of only around 1% to 4%. Despite a spike in profitability in late 2011, Ford still remains a firm which is barely profitable.
Revenue is Slowing
Since profit margin shows us how profitable a firm is in relation to the costs necessary of running the business, it makes sense to study the actual revenues that feed into profit margin. Rather than examining what outright revenues are, I feel that it makes more sense to study the growth in revenues. The growth in revenues is simply the percentage change between two periods of time. If we understand how revenues are changing, we can better understand if the company is growing or declining. By looking at revenue growth, we can see how the direct input into profit margin is behaving.
As can be seen in the chart above, revenue is not growing. During the past 5 years, Ford has only had around 2 years in which revenues were actually growing. What this means is that each year the firm is earning less and less, and if it does not match these decreases with decreases in costs, the firm's health could potentially be in serious danger. Since profit margin is already very small, decreases in revenues lead directly to a decrease in profit margin. The simple relationship between revenue decline rate and small profit margins strongly indicates that in the future Ford may cease to be a profitable business.
A shrewd investor may note that my fundamental argument is based upon profit margin and revenue growth rate as percentages rather than outright dollar figures. I believe that this is more relevant than the actual revenue or profit margin dollar number. Here's why:
In the chart above, net income is shown. Net income is basically revenues minus expenses. Since the middle of 2008, Ford has barely scraped by in terms of actually being a profitable organization. As I noted, revenues are declining at an increasing rate. With revenues of $33 billion and a profit margin of only 3%, if revenues decline even one more year by the current rate of 6.3%, Ford will be losing over $1 billion per year.
In light of the fact that Ford is struggling for profitability, I have conducted a study to determine if the past could be a rough guide to how Ford prices seasonally behave. If we are able to determine times of the year in which Ford's stock prices historically fall, then we can best position ourselves to capitalize on the potential decline of Ford. During this study, I determined how the stock price of Ford changed between August and each month of the year until December for each of the 35 years of public data available. Even though the company was founded in 1901 and was publicly listed in 1956, I believe that this past 35 years of data is best representative of the current business climate. For example, in the chart below, the first row shows key statistics for August through December of each year. During this time period, the stock price declined in 57% of all years and these declines on average resulted in a 15.13% drop in share price.
No matter which way you examine the data, Ford historically falls in share price between now and the end of the year. Even if you were to only hold the stock between August and September of each of the past 35 years, the stock would more than likely decline in price. It is interesting to note that historically, the highest probability time period of decrease is between now and November. This said, I view this as the best trading opportunity for willing market participants. For individuals looking to short Ford, I believe that the duration of their trade should be between August and November. I believe that history tends to repeat itself and cyclicality can show us statistical patterns which have held up in the past and may hold up in the future.
One Bright Spot
Despite the bearish fundamental condition of Ford, one bright spot is that Ford recognizes its situation and is currently holding its expenses near decade lows.
As the chart clearly shows, Ford has been operating at relatively low expense levels for the past 4 years. This means that the firm is better able to preserve their earnings and increase their net income. If Ford is able to maintain these lower expenses while continuing its current operations, Ford may be able to slowly grow its net income as well as grow itself out of its current operating environment.
Prior to initiating any trade or investment, I like to first assess the technical picture. Technical analysis can help us make an informed decision by factoring in the current price trends of the market. In the chart below, I have shown the very strong downtrend that the stock is currently in. Ford has made new lows since it began its decline in April. I believe it could continue making new lows in the immediate future; however, I advocate waiting rather than simply jumping into the market. Waiting for the price to make a new 52 week low before shorting can filter out bad trades and keep us out of the market when the trend doesn't favor our idea. This said, I will treat $8.80 as the short entry. If prices reach this level, it is time to short because the downtrend is resuming. Additionally, it doesn't make sense to enter a trade without a stop loss in place. If we believe the market is traveling a certain direction, we need to have a logical point in place that tells us when we are wrong and shows us when to exit our short position. The most logical point for a stop loss is above the past month's trading range. If prices break above this trading range, then we are no longer in a technical downtrend. For the short trade, I consider $9.45 to be the stop loss location. If price travels above this point, the trade should be exited.
Perhaps the most telling technical sign that Ford is nearing a collapse in share price is found by examining the monthly price chart below. A clear head and shoulders pattern is forming. The head and shoulders pattern is one of the most popular and widely-watched chart patterns within technical analysis. It indicates that markets are topping and that the trend is reversing. It is very interesting to note that our short entry at $8.80 is exactly where the monthly head and shoulders pattern will be validated.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.