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Analyzing Auto Stocks

2012-02-20 09:05:22

May 26 2008 | Filed Under Economics , Options , Retirement , Stocks

Automobile companies have been a staple in American society since the early 1900s. For nearly the same amount of time, investors have been trying to determine the best ways to go about analyzing the industry, individual companies and stocks - above and beyond the good old-fashioned P/E ratio. The following article will detail some of the items that can have a positive or adverse impact on the earnings and stock prices of domestic automakers.

Jobs and Unemployment Play a Role

To qualify for financing to purchase an automobile, individuals must typically show some source of income. By extension, jobs and unemployment rates can have an influence on car sales. According to Reuters and Left Lane News, December 2007 unemployment ticked up in numerous states over 2007 and auto sales simultaneously slumped. The number of jobs and the average person's confidence that they'll keep their job can both be a big determinant of auto sales. (For more on the auto industry, read The Industry Handbook - The Automobile Industry.)

Borrowing Rates

Many car buyers finance their purchases. If the borrowing rates become too high, buyers may shy away and instead spend more money maintaining their existing vehicles.

Over time, auto sales data and rate data have shown a correlation. The one period that stands out is how borrowing rates impacted sales after September 11, 2001.

In November 2001, many employers initiated a hiring freeze, mostly as a defensive mechanism against a slowing economy. According to the U.S. department of labor, unemployment rose, but domestic auto sales continued to rise at a fairly brisk rate according to CNN Money. Why was that? Many give credit to the fact that a large number of dealers and automakers were offering 0% financing or other favorable financing packages in order to lure in customers. (For related reading, see Pros And Cons of Leasing Vs Buying A Vehicle.)

In short, when analyzing and investing in auto stocks don't forget to factor in the potential impact of interest rate fluctuations and their possible impact on sales. (To learn more about interest rates, see Forces Behind Interest Rates.)

Labor Relations

U.S. automakers often have a disadvantage compared to their foreign counterparts. This is because a sizable portion of the U.S. labor force working in the automobile industry is unionized or under some form of union influence. Unfortunately, today's unions don't just bargain for safe working conditions as they did in decades past. These days, they aggressively negotiate for pay raises, medical and retirement benefits.

This is not to say that these individuals don't deserve the pay they are getting. In fact, given the hard work many of these individuals perform, it may be warranted. However, it can be expensive. In order to cover those expenses, the domestic automaker may have to reduce costs on production or raise the price of their cars. Both of these options can have an impact on sales.

Look for companies that have just negotiated a contract with their unions. This way, it is likely that it will be at least a couple more years before the two parties have to negotiate another contract that could crimp margins.

Tax Breaks

The average American saves very little each year. By definition, this means that when they get their hands on something like a tax refund, or if they experience some other type of tax windfall, they probably will spend it.

According to the National Bureau of Economic Research, in 2001, when the domestic economy entered into a recession, the U.S. government sent out rebate checks ranging from $300 to $600 as a stimulus, and within a six-month period most Americans had spent the money. (For related reading, see Recession-Proof Your Portfolio and Recession: What Does It Mean To Investors?)

The money was spent on a variety of items ranging from more traditional consumer goods to vacations. However, some of that money almost surely made its way to the automakers, again as evidenced by the above-mentioned 2001 U.S. auto sales numbers.

Environmentally Friendly Cars

While there are some exceptions, the majority of automobiles still run on oil byproducts, such as gasoline. The good news is that this is beginning to change. For example, battery operated cars and/or hybrids are becoming more popular. In addition, the government has been pushing automakers to produce more fuel-efficient vehicles, mostly to help cut down on emissions.

It's important to note that these efforts don't come cheap. In fact, the research and development (R&D) of such vehicles is likely to cost billions of dollars and take years to come to fruition. Keep a close eye on what companies are spending on R&D for environmentally friendly vehicles and try to determine how that might impact future profits, or how the company will be able to finance such initiatives. Much of this information will be available in the company's 10-K and most likely in the management discussion and analysis(MD&A) section or the section on future guidance. (For insight on fuel efficiency, read Hybrids: Financial Friends Or Foes? and Getting A Grip On The Cost Of Gas.)

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New Model Line Up

If a company doesn't have an exciting product line, its sales could suffer and/or the stock could too. For example, between 2001 and 2008 Ford (NYSE:F) stock has been in the doldrums. There are lots of potential reasons for its decline, including potential labor concerns and the health of the U.S. economy. However, its generally lackluster lineup of new cars has been blamed as well. Automakers including Honda (NYSE:HMC), Hyundai, Toyota (NYSE:TM), and others have been coming out with aesthetically pleasing new vehicles. And some folks have found these more attractive than Ford's offerings.

Try to keep an eye on a company's new cars and try to determine whether you think their models will appeal to consumers. Remember: the analyst community will likely be doing the same thing.

Tariffs

When the economy is struggling, some politicians will push for tariffs or taxes on imported vehicles. They argue that imports will then cost more to buy and that American jobs will be preserved because consumers will buy "American."

Trouble is, this doesn't always work out as planned. Foreign governments may then enact tariffs on goods, such as cars that they import and as a result the domestic automaker may actually end up generating less revenue.

When politicians start to bandy such legislation, read the proposal carefully and try to evaluate the potential impact on U.S. consumers as well as how other nations might react. (To learn more about globalization, read What Is The World Trade Organization?)

Bottom Line

Investing in auto stocks isn't easy. There are a number of macroeconomic and company-specific factors that must be considered. Investing in these companies often requires an extra level of patience and dedication, but the industry has proved it will be around for a long time.