As part of our process, we perform a rigorous discounted cash-flow methodology that dives into the true intrinsic worth of companies. In General Motor's (NYSE:GM) case, we think the firm is fairly valued at $32, indicating roughly 30% upside.
For some background, we think a comprehensive analysis of a firm's discounted cash-flow valuation, relative valuation versus industry peers, as well as an assessment of technical and momentum indicators is the best way to identify the most attractive stocks at the best time to buy. This process culminates in what we call our Valuentum Buying Index (click here for a presentation about our methodology), which ranks stocks on a scale from 1 to 10, with 10 being the best. Essentially, we're looking for firms that overlap investment methodologies, thereby revealing the greatest interest by investors (we like firms that fall in the center of the diagram below.
If a company is undervalued both on a DCF and on a relative valuation basis and is showing improvement in technical and momentum indicators, it scores high on our scale. General Motors posts a VBI score of 6 on our scale, reflecting our 'fairly valued' DCF assessment of the firm, its neutral relative valuation versus peers, and bullish techinicals. We compare General Motors to peers Ford (NYSE:F), Honda (NYSE:HMC), and Toyota (NYSE:TM).
Our Report on General Motors
Recent Sales Results
Sales at GM were also a bit weaker than expected, growing 4.7% year-over-year (6.8% retail) versus a consensus estimate of 7.8% growth. The October SAAR, according to the firm, came in at 14.4 million units, which is below last month's levels. Buick and Cadillac were the clear standouts, growing 14.5% each, as the two continue to make strides against competitors like Lincoln and Audi. Total passenger car sales grew 15% year-over-year, while crossovers and trucks grew 3% and 8%, respectively.
While we do have some concerns with respect to channel stuffing--the company's day's supply of inventory is running well above internal goals--we think the firm has made some meaningful strides in the luxury market. Volt sales also increased significantly, posting a monthly all-time high of 2,961 units sold, though performance continues to run dramatically below original forecasts. Still, the month was fairly solid for GM.
Our discounted cash flow model indicates that General Motors's shares are worth between $19.00 - $45.00 each. The margin of safety around our fair value estimate is driven by the firm's VERY HIGH ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $32 per share represents a price-to-earnings (P/E) ratio of about 5.8 times last year's earnings and an implied EV/EBITDA multiple of about 4.2 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 3.8% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 0.3%. Our model reflects a 5-year projected average operating margin of 6%, which is above General Motors's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 0% for the next 15 years and 3% in perpetuity. For General Motors, we use a 10.8% weighted average cost of capital to discount future free cash flows. For more fair value estimates, please visit our website at Valuentum.com.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $32 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for General Motors. We think the firm is attractive below $19 per share (the green line), but quite expensive above $45 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
We strive to answer a few questions that investors often ask: 1) What are the chances of a total loss of investment in this company? and 2) What is the chance that the company is really worth twice what I paid for it? The probability (fair value < 0) strives to answer the first question. It indicates the chance that the firm may encounter insolvency based on the characteristics of its cash flow stream, capital structure, and risk profile. The probability (fair value > 2x current share price) strives to answer the second question. It is our best estimate of whether investors are participating in a half-off sale by buying the company's shares at current prices.
Future Path of Fair Value
We estimate General Motors' fair value at this point in time to be about $32 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of General Motors's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $46 per share in Year 3 represents our existing fair value per share of $32 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements
Disclosure: F is included in the portfolio of our Best Ideas Newsletter. I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.