Auto Stocks: Value Investments Gone Wrong?

In 2004, motor vehicle sales were booming, as the economy was strong and customers continued to buy larger and larger vehicles. The stock prices of most car manufacturers (domestic and foreign alike) were at recent highs. Today is a different story, as the stock prices of GM (GM) and Ford (F) have plummeted from those highs, while Toyota (TM) and Honda (HMC) have held their own despite the tough environment.

Assuming investors couldn't see into the future (which would consist of high gas prices and a shift to fuel efficient vehicles); could investors have seen this coming back in 2004? After all, Ford and GM own some of the best consumer brands around - could they have represented value investments that just went wrong?

Not a chance. True value investors would have considered GM and Ford investments to be of the most speculative variety. Why? Debt levels. Here's a look at the 2004 debt to equity ratios of the four companies discussed above:
 

click to enlarge

Debt to equity levels much more than one make us a little bit uncomfortable, but debt to equity levels above nine are astronomical!

As we've discussed before, low debt levels allow flexibility, add more certainty to the estimated equity value, and allow a company to weather downturns and emerge from them stronger than ever (as Toyota and Honda appear poised to do). Going forward, make sure you know the debt levels of any company you plan on buying as a long-term investment.

Disclosure: None

Comments

[investor88:]

Saj has made a good point, a high debt level is almost without exception to be treated as a speculative stock. One can make money on speculative stocks provided we recognise it as such and mistaken them for long term value stocks.

2008 Sep 25 08:43 AM

[ali k:]

Great point. Just because a company's stock price is cheap does not necessarily make it a value pick.

2008 Sep 25 09:17 AM

[Chris B:]

Good point. F and GM only continue to exist because they continually issue more debt. At some point the credit runs out. Before that point, they lost the flexibility needed to adapt to a changing world.

Hmmm. Is that a metaphor for the U.S?

2008 Sep 25 09:39 AM

[elroy:]

Debt = risk.

Risk is rewarded with potentially higher returns.

In and of itself, debt doesn't make it a bad investment. Back in 2004, the truck business was still running at flank speed. Whether debt is bad or not depends upon the three intertwined cycles -- overall market, industry and company. Back in 2004, all three were favourable. Now, the first two are unfavourable for all, but the company perspective -- products, etc. -- are very favourable for Toyota and Honda.

Why are Toyota/Honda so debt free? Good management? Good products? The answer is yes -- but that's not the whole story.
The Japanese protect their industries and the companies based there have a profitable home market from which to build a world market.

Korea is even worse.

If the US is to ever become an industrial power again, it must have the same trading rules as it's partners -- whether it be Japan, Korea or China. This should be a major issue in the presidential elections, but obviously no candidate understands it.

2008 Sep 25 10:38 AM

[Miken:]

Toyota is holding their own? In Feb, 07 TM was at $135.50. Yesterday it closed at $88.25, a decline of 35%.

2008 Sep 25 10:54 AM

[Miken:]

Honda fell 32% from Feb,07 to Mar,08, but has recovered a little since then.

2008 Sep 25 10:58 AM

[Stephen Ros...:]

Exactement. Look at Pilgrim's Pride. It looked cheap but succumbed to high debt.

2008 Sep 25 01:38 PM

[epeon:]

You guys really just missed the whole point. F and GM are managed by the UAW. They are not, and have not, been managed for the stockholders in decades. As long as F and GM have the debt of the pension plan, the cost of unionized workers, and the restrictive work rules; GM and F will never be a good investment.

Note: both Toyota and Honda are non-unionized.

2008 Sep 25 01:47 PM

[Deweyp:]

By necessity the restrictive, destructive union rules are slowly being reduced, but not fast enough to prevent the wholesale damage to the big three. Elroy hit the nail on the head, but the protectionism involved extends to currency manipulation, which I believe is the biggest piece of the pie, but at the expense of the Japanese citizens, because they pay considerable more for the products imported to their nation than Americans do. They can do this and give their auto and other industries a huge leg up, mainly because the citizens of Japan have such a high savings rate. The big three have historically provided a higher standard of living than most other industries, and they should be applauded for that, except that, with world competition as strong as it is now, it has no where to go. The American auto industry is far more important than the jobs that are provided to our labor force, although that is important. As history can verify, the auto industry has been a key player in our national defense and will continue to be, if it remains strong. Allowing that industry to go away, as some would suggest, is not the smartest thing to do. We should support it (although with much oversight) and insure it continues to be a strong segment of our manufacturing base.

2008 Sep 25 03:14 PM

[User 269999:]

Japan protects the home market by making it difficult for foriegn brands to sell there--their dealers cannot sell dual brands and import restrictions are cumbersome. Also, the Japanese vehicle license fees and registration taxes go up with the age of vehicles--making it beneficial to buy new (support the market) and the used products are sold offshore to New Zealand and The Philippines among others which has ruined the automotive industry in those countries--New Zealand has no auto assemblers now compared to all the majors 10 years ago.

2008 Sep 25 05:35 PM