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Valuing the Automakers Securities

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Valuing the Automakers'Securities

The most important aspect in valuing the U.S. automaker stocks is timing the stocks' probable periods of outperforming the market. Among the varied valuation methods, the recommendation made here is a matrix approach-using several methodologies to come up with target prices and then overlaying on those targets a consideration of the subjective issues.

No hard-and-fast rules exist for buying and selling automotive stocks, so analysts should be skeptical of anybody's decision rules, including mine. Trading auto stocks is an art, not a science. Also, in North America and other developed markets, this industry is highly cyclical. Understanding that aspect, and realizing that an analyst's purpose in life is to outper-form the market, I would suggest that "Timing the Automakers' Securities" might be a more appropri-ate title for this presentation than "Valuing the Automakers'Securities."

Stock Perfonnance over Time

The cycles for the automotive industry generally coincide with those of GDP, but they are much more pronounced than for the economy as a whole. The U.S. auto industry's cyclicality is evident in Figure 1, which shows light-vehicle sales from 1963 through 1992 and estimates through 1996. As the industry matured, the sales cycles became more pronounced. The industry is now mature and depends for its growth on discretionary spending by consumers, businesses, and governments.

The cyclicality in earnings is even more pro-nounced than it is with sales, as seen in Figure 2 for the Big Three (GM, Ford, and Chrysler). The figure shows a classic case of leverage. With the 1990 UAW and CAW (Canadian Auto Workers) labor agree-ments, labor became much more of a fixed cost than previously, which is largely the reason earnings in the most recent industry trough were generally worse than they were in the 1981-82 recession, de-spite higher unit sales.

Thus, analysts are dealing with an industry and companies in which the sales and earnings oscillate

sharply around a slowly growing trendline. The stocks also behave in a very cyclical fashion, as shown in Figure 3. Graphing relative performance would not change the picture much, except that the GM line would change from generally flat to a 28-year downward slide with a few bumps in it.

Like any cyclical industry, the auto stocks are not long-term, buy-and-hold stocks, which makes them interesting investments. Investors can make huge amounts of money if they play the stocks correctly, and they do not have to be too precise about picking the tops and bottoms in order to do it.

The relationship between these stocks' outper-formance and the sales cycle varies, and the stocks show precious little consistency. The performance of the stocks of the Big Three during various automo-tive sales cycles are examined in detail in Figure 4, Figure 5, and Figure 6. As shown, the outperfor-mance had no consistent magnitude or duration. The auto stocks never began or ceased outperform-ing at the same time, although they generally started to outperform before a sales trough and stopped before a peak.

The sales data are three-month moving averages of light-vehicle seasonally adjusted annual rates of sales (SAARS). (The top panel of Figure 4 shows GM's auto sales alone rather than light-vehicle sales.) The figures show the stock performance of each of the Big Three companies and the S&P 500, each in-dexed to be 1.00 in the month that outperformance began for each of the cycles; the distance between the lines represents the outperformance. Thus, a widen-ing gap indicates the stock has outperformed the S&P, and a narrowing gap indicates it has underper-formed. Generally, the trough in light-vehicle sales will be evident on the graphs, but many of the sales

46

Figure 1. Light-Vehicle Sales

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peaks do not appear because the outperformance often stopped well before the peak.

As shown in the top panel of Figure 4, outperfor-mance began for GM stock in December 1966 and stopped five months later, in April 1967. Auto sales troughed in March 1967; the company began outper-forming four months before that and quit one month after the trough with an almost not-worth-the-effort outperformance of 14.3 percent. During the next period, shown in the middle panel of Figure 4, the outperformance was once again anemic. The sales trough was not until December 1970, and GM stopped outperforming in August 1970, before sales ever turned up. GM's best effort, shown in the bot-tom panel of Figure 4, was in the 1982-84 period, when it managed to outperform by about 104 per-cent.

Ford stock's outperformance for three periods is shown in Figure 5. Ford did not sustain any outper-formance during the 1967-68 cycle. The interesting

Figure 2. Trailing Fourth-Quarter Earnings of the Big

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