This Sector's Down 72%... And It's Still Expensive
By Ian Davis, editor, Quant Trader
March 10 , 2008
There comes a time in every economic expansion when companies start declaring themselves "recession proof."
For the automobile industry, the year was 1999. The executives of DaimlerChrysler and Ford suggested their companies were no longer truly cyclical... They could remain profitable even in an economic downturn.
Of course, this declaration came five months after the auto sector reached its all-time market peak – a level the sector has not even approached in the nine years since.
During the following dot-com crash, General Motors' shareholders lost 58.8%, and the stock of "recession proof" Ford Motor Company fell 69.3%. The non-discretionary automobile industry turned out to be discretionary. The staple was a luxury after all.
General Motors actually did turn a profit throughout the recession – albeit a smaller one than in previous years. However, Ford operated in the red for most of 2002.
The following chart shows the price action of the Datastream U.S. Automobile Index since 1995.
Automobiles: Classic Guillotine & Sandpaper
Right now, the automobile industry is in what legendary market analyst Bob Farrell calls the "sandpaper" stage.
You see, practically all bear markets unwind in the same fashion. Here's how Bob describes it: "First there's the guillotine stage – the sharp decline. That creates fear. Then there's the feeling of being sandpapered to death. In place of fear come feelings of apathy, lack of interest, and finally, hopelessness."
High oil prices, a U.S. recession, and huge pension responsibilities make the automobile industry seem hopeless. To top it off, investors are faced with a sector that is 72% off its high and still relatively expensive.
The price-to-earnings ratio of U.S. automakers is around 38 right now. (To put that in perspective, high-growth Internet stocks have a P/E ratio of 38.8.)
The industry is expensive because the sector's earnings have declined at an even faster rate than its share prices. In 1999, the components of the Datastream Automobile Index earned about $36.20 per unit. Today, that number has dropped to only $3.80. And some of the components, like General Motors and Ford, are operating in the red.
The other valuation measures don't look any better... The sector's book value is currently negative, meaning carmakers as a whole have a net worth of less than zero. In addition, the dividend yield is about half its median value.
But I'm not interested in shorting this index. The easy money has already been made. Right now, we are in the late stage of a bear market in U.S. automobiles. The level of hopelessness and apathy is so great that any positive news could lead to a steep rebound in these stocks, as shorts race to cover their positions.
So will this sector ever be a buy?
I believe so, but not before the U.S. economy stabilizes. Take a hint from the automobile manufacturer's performance during the dot-com crash. When Americans have a tight budget, they're not interested in buying new cars.
Good investing,
Ian Davis
