Are Low P/E Ratios The New Normal For Car Companies?

by: Jacob Steinberg

It is truly difficult to identify the ideal P/E ratio for any company. Some suggest a rule of thumb where mature companies should have a P/E ratio of 5-10, moderate-growth companies should have a P/E ratio of 11-20 and aggressive growth companies should have a P/E ratio of 21-40 depending on where they are in the growth cycle. Others say that ideal P/E ratio depends on the industry and one should take the average P/E in a given industry to tell whether a company is below or above such average to determine if that company is overpriced or underpriced. Yet, there are always amazing examples. You have Chipotle (NYSE:CMG) with a P/E ratio above 50, Amazon (NASDAQ:AMZN) with a P/E ratio above 100 and Apple (NASDAQ:AAPL) with a P/E ratio under 15. Even more interestingly, car companies are enjoying historically low P/E ratios at the moment. In fact, car companies have been enjoying these low P/E ratios for a couple years now. It makes me wonder, are the low P/Es new normal for car companies?

Take Ford (NYSE:F), for example. The company currently has a P/E ratio of 2.18, even though this is misleading due to a one-time tax benefit received by the company last year. Still, even without that, the company would be enjoying a very low P/E ratio. Ford's forward P/E ratio is 7 for 2012 and 6 for 2013. For the last 10 years, the company's average P/E is 12.70; however keep in mind that Ford spent a portion of the last decade as a loss generating company. The company's current and future P/E ratios are well below its average.

The next example is General Motors (NYSE:GM). The company currently enjoys a P/E ratio of 6. The company's forward P/E ratio is 5.6 for 2012 and 4.7 for 2013. The company's historical P/E ratio average is about 13. Nissan (OTCPK:NSANY) is an example from Japan. The company's current P/E ratio is 9 and forward P/E ratio is 7.48. Volkswagen and BMW are our European examples. Volkswagen's (VLKAY.PK) current P/E ratio is 3 whereas the company's forward P/E ratio is below 2 for 2013. BMW (BAMXY.PK) enjoys a P/E ratio of 7 and a forward P/E ratio of 5. Volvo (OTCPK:VOLVY) also enjoys a trailing P/E of 8.8 and forward P/E below 8.

The only exceptions I could find to this rule were two Japanese companies, Toyota (NYSE:TM) and Honda (NYSE:HMC). Toyota's current P/E ratio is 33 and forward P/E ratio is 12.45. Honda's trailing P/E is 21 and forward P/E is 9. These are still not very high numbers and they are largely affected by the production disruptions caused by the earthquake and the following tsunami.

It looks like low P/Es are the new normal for the auto industry as the investors remain very skeptical of this industry. If this trend continues, car companies might start buying back their shares at a rapid rate or increase their dividend rates significantly. After all, having a P/E ratio of 5 means that a company could technically buy back one-fifth of all its outstanding shares using last year's earnings alone. Of course, the action of buying shares back would increase the share price to a point.

The car industry is expected to grow at a decent rate in the next decade. Many people in the developing nations are buying their first cars whereas many people in the developed nations are replacing their 10-year old cars with newer ones. Cars are getting more fuel-efficient each day, making them more attractive to potential buyers in the age of expensive fuel. In addition, many car companies are clearing up their balance sheet as they continue paying off a substantial amount of debt.

The biggest threats in front of car companies are high material costs, increased government pressure for building more environment-friendly cars and slowing world economies. Last year, most car companies posted impressive results despite all these problems and they will continue to post strong results for the foreseeable future.

I am long Ford, GM and Volkswagen and I might add some BMW to my portfolio in the near future. I suggest everyone add one American and one international car company in their portfolios.

Disclosure: I am long F, VLKAY.PK, GM.