I’m not particularly happy that General Motor’s (GM) engine is sputtering this year.
But it’s important to remember that deep-value plays rarely work on the timeline you expect. It often takes time for the market to appreciate the value and award a suitable stock price.
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I’m far more willing tolerate an uncooperative stock when I’m getting paid, and General Motors is certainly no slouch in that department.
Its 4.3% yield was one of my reasons for recommending the stock at the end of last year.
Still, I do expect to earn better than a 4.3% total annual return. And I expect that once the recent spate of bad headlines passes, GM will finish the year strong.
Let’s dig deeper into General Motors’ woes. Auto sales have been particularly strong over the last couple years, leading most auto analysts to expect sales to be fairly weak this year.
GM recently announced that industry sales would be lower than originally thought.
But it’s not as if sales have completely fallen off a cliff. GM lowered its forecast from around 17.5 million to a little above 17 million. That’s not exactly crisis material in my opinion.
Yes, dealer inventories are higher than ideal, and that means General Motors will likely need to further curtail production. But this is a minor correction after an exceptionally strong 2016.
Furthermore, GM stock wasn’t exactly priced for perfection. As I write this, the stock sells for an almost ridiculous 6 times expected 2017 earnings and 0.3 times sales.
That’s not just cheap, that’s “going out of business” cheap. Investors are so skeptical that GM’s strong sales of the past few years are sustainable, they’ve effectively priced in a major blow-up.
You always have to be careful when looking at the P/E ratio of a highly cyclical stock like an automaker. When you’re at the bottom of a cycle, an auto stock can sport a high P/E ratio and look “expensive” when it is actually quite cheap.
In my opinion, the temporary decline in earnings created a spike in the ratio, sending the wrong message. Likewise, an automaker can appear cheap, with a low P/E ratio, at the top of the cycle when it is actually quite expensive.
I get that. I really do. But GM’s price/sales ratio, which is less prone to wild swings, has also been trending lower for several years.
When a stock is priced for perfection, it nearly always ends up disappointing. Something comes along and knocks the stock off its perch.
But the exact opposite is true of stocks that have the absolute worst-case scenario priced in. If reality proves to be anything short of disaster, the stock will generally surge higher.
It may happen this quarter… or it may be several months from now. But because of the high dividend yield, we don’t have to time this exactly right. Being early simply means that we milk the dividend a little longer.
It’s good to know that I’m not alone here. Analytics site GuruFocus reported that Warren Buffett, David Einhorn and David Tepper all have significant holdings of GM stock.
And while I would never buy GM purely because these high-profile investors were buying it, it does give me an additional degree of confidence.
Charles Lewis Sizemore, CFA is the principal ofSizemore Capital Management, a registered investment advisor based in Dallas, Texas. As of this writing, he was long GM.
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