Auto-manufacturing stocks saw strong gains in the first five months of the year, but since early June, they have been falling as a group. The big two in the U.S., Ford (F) and GM (GM), have dropped by 22% and 24%, respectively, in that time. There is an old market saying that you should never try to catch a falling knife, but in this case, I will make an exception to that rule. Both F and GM are buys at these levels for three reasons.
1. Rare Value
Let’s get one thing out of the way. In stock analysis, as in life in general, a low price doesn’t necessarily mean value. If F and GM had fallen by over 20% because their businesses had collapsed or were about to collapse for some structural reason, they would still be expensive, even at the lower price. If, however, the price falls because of an inherently short-term issue or a warped investor perception but underlying fundamentals are still strong, they can be seen as offering value.
And that is a scarce commodity in the stock market these days. An awful lot of assumed good news has to be priced in for the major indices to keep hitting new highs as the Delta variant causes a resurgence in the disease. In those circumstances, when indices trail and forward multiples are well above historical norms, a below average P/E should always draw attention, but especially so when the low multiple is not a product of expectations for weak or even negative future growth.
To consider value, analysts often use the PEG ratio, a number derived by dividing the trailing P/E of a stock by the average annual growth, as forecasted by Wall Street analysts for the next five years. A PEG ratio of below 1.0 is considered to indicate value, so Ford, with a PEG of 0.18 and GM with 0.78, are both technically value stocks.
That, in itself makes them worthy of consideration, but only if things are going to get better, and there are reasons to think that is the case.
2. The Temporary Nature of Supply Disruptions
The main reason for the decline in auto stocks over the last three months is the worsening supply constraints, which have caused a cut in production and a reduction in revenue and profit forecasts. There is no doubt that the supply chain issues in the industry, particularly when it comes to computer chips, are bad. But they are also by nature, temporary.
The problem is that the laws of supply and demand, which would normally bring things back to equilibrium have been distorted, but distortion is not the same as destruction. If there is a shortage of chips, or anything for that matter, the price tends to move higher, which encourages investment in more production. That investment, though, has been delayed in this case because the pandemic has restricted trade flows around the world. However, unless you believe that the world will be actively fighting Covid forever, those restrictions will ease at some time and the demand for chips, and therefore autos, will be met.
3. Retail Patterns Indicate Sustained Demand
So far, shortages have not hit profits at Ford and GM too hard. Both companies beat expectations for EPS last quarter, largely because the strong demand for news vehicles enabled them to raise prices. Trends in non-auto retail suggest that the pricing power is going to be here for a while longer, even as supply and sales volume are restored.
Discount retailers Dollar Tree (DLTR) and Dollar General (DG) both reported earnings yesterday, and both gave pessimistic outlooks along with their results. By contrast, however, high end and luxury retailers such as Tapestry (TPR) expect performance to continue. Consumers are buying big ticket items, not dollar store stuff. Price sensitivity among consumers therefore seems to be low, which will enable car manufacturers to keep prices high as they increase output.
Auto stocks have been retreating from their highs for a while, but any one of these three things taken alone would be reason enough to believe that the selling of F and GM is a bit overdone. They clearly indicate that this particular falling knife is worth grabbing, so averaging into both stocks over the next few weeks or months looks like a good long-term play.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.