Second only to Do you think we’ve hit a bottom?, the most common question I hear from folks is: Where should I be (or are you) putting money these days? It is usually followed up with some statement about how terrible the stock market is and/or how impossible real estate is right now.
Then, I get hit with the request for affirmation-the old, XYZ company is pretty beat up. What do you think? Most recently, the request has been about General Motors and Ford. Before that, Bank of America, AIG, and Fannie/Freddie.
Why do I call this a “request for affirmation”? Most of the time, the people asking have been decimated in the markets and are feeling the need or desire to make it back quick. They want to take a gamble on a beat down company, not because the business is sound, but because what was a $20 or $50 or $80 stock is now a $2 or $3 stock.
So…coming back from a long (and long overdue) break, let’s get back to the basics. And to do that, we’ll pick on General Motors again.
SOME STOCKS ARE CHEAP RIGHT NOW; SOME ARE NOT
At any given time, in any given market environment, the enterprising investor can usually find a bargain. Though stocks in the aggregate move with the markets (because they are the markets), individual stocks move independent of the markets.
The markets are a force on all stocks. When the markets are down 30%, 40%, or more, long-term upward movements in a stock price are usually held back, not reaching their full potential in the down market. When the markets are flying high, overpriced, mediocre, and bad companies can fly high with them.
We’ve seen a few examples of this over the past seventeen months. One that is in the news and on peoples’ lips is General Motors-a company we’ve discussed here a few times in the past. Here’s the chart since F Wall Street started on June 25, 2007:
On the next chart, I’ve highlighted in green the times and prices where I felt GM was a bad business and not worth owning:
IS GENERAL MOTORS CHEAP?
General Motors is down; but, down and cheap are two different things. Over the past forty seven years-a sufficient time to judge investment results-General Motors has returned roughly 1.8% a year to investors. Now, you may think that judging performance at today’s prices is unfair; so, assuming GM was $15 a share, it would have returned 4.4% a year to investors over the past forty seven years.
During that time, General Motors had a CROIC of roughly 4% or so; thus, investors purchasing General Motors at fair prices over the past forty seven years should not have expected much more than a 4% or so return during that time.
So, is it cheap? I can’t tell you that-there is too much uncertainty. If they receive and continue to receive gobs of money from the government and ultimately survive this mess, it won’t change the fact that GM-and pretty much any auto maker-is a mediocre or bad business (from a capitalist perspective).
Now, the question…
DO YOU THINK IT’S CHEAP?
Long-time readers know that I shied away from financials for a long-time, even though there is blood in the streets. Why? They are outside my sphere of confidence and competence. Sure, I’ll miss some high fliers when the economy is better three…five…ten years from now; but, I don’t have to be in those high fliers. There will always be blood in the streets somewhere.
General Motors at $4 a share. Cheap? Ugly? Don’t buy it just because it’s down. Don’t buy it just because Wall Street is talking about how “cheap” the price is. (The table below shows how “wise” Wall Street has been on General Motors for the past two years or so.)
Rip open the annual and quarterly reports, and decide for yourself. Looking at the latest quarterly report, I immediately realized that, if GM were to ever make it out of my “No” pile, it would have to go in my “Too Hard” pile.
We know GM is in a liquidity crisis-a major liquidity crisis. Here’s their plan for solving it:
We will continue to identify and develop additional sources of liquidity, including a broad global assessment of our assets for potential sale or monetization. We believe that we can raise significant liquidity from asset sales without negatively affecting our strategic direction. In addition to asset sales, we will also continue to access global capital markets on an opportunistic basis when the global capital markets are available to access on terms which are acceptable.
Be wary of the managers that tell you that they can sell a significant portion of the company’s assets without negatively affecting the business. I don’t know what GM’s “strategic direction” is; but, without assets, I know in what direction it is headed.
If the company has to rely on stock and bond offerings to keep afloat, look out. (That’s the “we will also continue to access global capital markets” line.) Just ask the folks over at Amylin.
What are the odds that GM will get any money other than government money? Slim to none, short of a complete takeover. So, a little more thought has to go into this.
GM’S “OUTS”
In poker, an “out” is a card or series of cards that will give you a winning hand when you are behind. I think GM’s outs are long-shots at best:
- Operate under bankruptcy protection.
- Go belly up and liquidate.
- Be taken over.
- Get a life-line from the government and/or some big investor(s) and fix its problems.
The problem with bankruptcy protection (among others) is that it shafts its suppliers and all but forces the other auto makers into bankruptcy protection to be able to compete. Then again, the odds are stacked against GM to compete under bankruptcy protection because it still faces fierce oversees competition in a lowest-price-wins product war for business from customers that, in the aggregate, have little to no brand loyalty.
We’ll assume that “belly up and liquidate” is not an option. It may be the only course; but, this would automatically disqualify GM as an investment at today’s prices.
General Motors can be taken over by a competitor. But who? US auto makers don’t have the means to do so, and foreign auto makers are snatching market share and building and selling vehicles for cheaper. Thus, a GM acquisition would be entirely lopsided in favor of GM, and no intelligent company would make that deal. (I liken it to Bank of America’s acquisition of Countrywide. It was entirely lopsided in favor of Countrywide. What the hell was BoA thinking?! A complete waste of shareholder money!)
GM NEEDS A PLAN
So, GM needs a plan to cut expenses and increase liquidity. By now, you probably heard about the private plan debacle at the Washington hearings. Management seems to be more concerned with squeezing the last nickel out of GM than with making the painful sacrifices necessary to turn the company around.
What should be in the GM plan? Once management is dumped, the next step is to take care of excessive expenses. Then, the company needs to shed some inventory. Inventories have been on the rise which means that the company has been burning through cash to build inventories that nobody is buying.
How do you shed inventory? First, GM needs to slow production. Then, they need to firesale the rest before it is firesold in bankruptcy proceedings. How do you firesale inventory? 50% off.
GM has $11.9 billion of “Finished product, including service parts.” Sell it. Sell it all, at 50% off. “Oh, but we don’t want to take a loss!” Wrong-you have already taken the loss and you continue to take the loss. An inventory firesale serves a number of purposes:
- It raises up to $6 billion in cash;
- It reduces expenses associated with storage, transportation, etc.; and,
- It is brilliant marketing.
The third point is the key. Auto commercials are ineffective and expensive. Thus…pointless, but necessary. A better way to market your product is to put every Tom, Dick, and Jane into a Chevy, Buick, Cadillac, HUMMER, whatever. Everyone is driving them; so, everyone sees them all the time.
And, it forces a greater need for your products. GM makes parts. When you have the lion’s share of the market because you gave your cars away, you create massive demand for your parts and service.
BUT…IT’S TOO HARD
I could go on for hours; but, it all adds up to one thing: GM has very severe problems. I think that they are fixable; but, you need the right management. And GM does not have the right management for the job.
GM is down. It may even be cheap. But, the best I could hope for (note the key word-hope) is to pick up a mediocre business. Hardly a smart move when, in this sort of market, there are so many highly predictable businesses at or near attractive prices.
So, I’ll move on.
But not today – it’s Thanksgiving here in the US. Happy Thanksgiving all!
Filed under: How to Think About Stock Prices
Related Stocks: GM
Why doesn’t someone forward this to these mutual funds (http://finance.yahoo.com/...) so they can save their investors some money?
Any update on the book?
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Excellent post, In a time where’s managers are “blaming the economy” for their shortcomings.
Its sickening… Lehman Brothers, AIG, …. they were all bought by the “professionals”.
Thanks Joe, your periodical update gives me RELIEF!! I cannot tolerate the garbage that gets spread by most “investors” (if you can call them that!! They love that title).
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I think Joe could be missing the forest for the trees — we are looking at the mother of all “workouts.”
The government has made it clear that they will bankrupt the entire country before they let Goldman Sachs or Citi fail. It has nothing to do with how terrible or great their businesses are.
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In response to the question, where should I be putting money these days? This may be the mother of all buying opportunities for high grade/investment grade corporate bonds. Better then the 80s and 90s because treasuries are much lower and the credit spread is over compensating for default risk while collectively the U.S. government is hell bent on preventing a global economic depression circa 1930s. The coming Obama stimulus package will have everything, but the kitchen sink in it to help consumers while the Fed and Treasury are combating corporate borrowing rates which should help keep the reins on unemployment. I would say that they are being somewhat effective and are signalling they will do whatever it takes. Keeping the reins on unemployment does not mean halting the rise of unemployment by the way. It means keeping unemployment from raging out of control.
Compared to equities high grade bonds are very cheap, so while collectively stocks stagnate good bonds are providing income (both through capital gains and interest) with a known workout endpoint. Equities that would offer comparable value to bonds would be high quality dividend payers or businesses with the ability to grow through rational re-investment of internally generated cash flow. Of course, individual equity workouts still can offer way more upside. As you probably know, the equation that should be driving your decision is reward vs. risk. In particular what’s the downside and what are the probabilities for your return scenarios? What’s nice about bonds sometimes is that unlike most equity investments (save workouts) you know the endpoint of your investment commitment. If you can rule out default between the time you enter the investment and maturity, you get paid to wait.
On GM and the other U.S. car companies, there is value in the assets, but it is a very complicated analysis. I think that including the government in any solution would likely lead less valuable company following a reorganizaton due to the political pressures that would decrease the ability to make some politically unpleasant decisions that are needed. Fundamentally, the U.S. car companies have, I think around 40% of the U.S. market share, their product quality collectively is now on par with foreign competitors, and they are reversing the incredibly stupid strategic decision to abandon the small car market to the competition. A 40% market share has value, you just have to be able to size the companies correctly for revenues and generate some margin. That comes through bankruptcy. In the end, somebody like Wilbur Ross will end up glomming together an integrated car company out of the parts that has value and will be a sustainable enterprise. It’s not however an easy investment but one loaded with work and risk. Consequently, it will offer great upside to that investor, but the current equity holders are probably dead. At best they might get some warrants out of a reorganization. In the current markets, there a much easier and less stressful investments to be found.
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In response to the topic, we can conclude that GM is likely a risky bet for us non-conventionalist business investors.
From our Philosophy(F*ckwallstreet), in investing in businesses that have favorable economics which are consistent throughout our holding period. (excellent excess, dominance/moat and a fair price).
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erm so many mistakes… let me rephrase>
From our community’s Philosophy which includes:1- investing in businesses that have favorable economics that will be 2- consistent return excess cash throughout our holding period, then considering GM we can see there’s nothing good (because its moat is weak in other words).
That should suffice for us… let the naysayers on television or analysts make predictions about how GM will be a good buy in say…22 months time. (will be sad to see institutions buying)
I commend Joe, all of this makes for one great discussion
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You have some good ideas about GM. I think back to Warren Buffet in his early days at Berkshire Hathaway, stuck in a rut with a declining textile business. Instead of asking for a govt bailout or import tariffs, he made the decision to exit the business with bad economics and move to one with better prospects. Maybe GM’s best decsion is to punt the auto business entirely – sell off the inventory, liquidate the plant, equipment and real estate, pay off all the creditors and invest all the proceeds into lending money to people who want to buy Toyotas and Hyundais. This is not what anyone wants to hear but as a course of action it probably makes more sense than begging for money from a bunch of Washington pinheads to prop up a moribund industry. If GM is not willing to do what it takes to make the company as currently configured work, maybe the best idea is to tell everyone involved (especially the UAW and Congress) to go to hell and serve the existing shareholders as well as possible.
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To be clear, I think that GM is a bad business and not worth owning right now…even at $3 or $5 a share. There is definitely value in the assets; but, is it enough to offset the liabilities in the event of a liquidation?
As Jeff said, it’s a very tough valuation. Like most auto manufacturers, GM resides in my “No” pile. If I really wanted to take a look at it, I’d be surprised if it made it past my “Too Hard” pile.
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GM means “Good bye Money”, what you suggest is remarkably similar to what Studebaker did in the mid-1960s. Studebaker left the automotive business but continued as an investment holding company.
Joe, as a car guy and as an investment guy I’ve been paying a great deal of attention to GM’s plight for years, I don’t agree with your assessment of the effects of an inventory firesale, most particularly this bit:
“And, it forces a greater need for your products. GM makes parts. When you have the lion’s share of the market because you gave your cars away, you create massive demand for your parts and service.”
#1 GM doesn’t make very many parts anymore. GM has sold off or spun off most of their parts making businesses. Delphi, which has been operating under Chapter 11 for several years now, is the biggest and best example of this. Even their AC Delco parts brand has been hollowed out by outsourcing and exists only as a brand name, the last AC Delco plant was closed several years ago. The replacement parts business contributes next to nothing to GM at best.
#2 The dealerships that provide the service are all independent businesses and the profits from their service departments stay at the dealership level. GM gets virtually none of this revenue. Today the service department and used car lot of a car dealership are by far the biggest profit generators, new car sales departments generally contribute little.
I do agree with your overall assessment of GM though. Your investment logic is very sound. I wouldn’t put GM into my own “Too Hard” pile but it is absolutely and unequivocally in my NO pile.
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GM and F are priced very low, but the idea that they are cheap (and thereby inferring that they might be value candidates) is false logic. Look at their historical (10-year or longer) returns on capital and equity, as well as their historical earnings and book value. They hold no competitive advantages as defined by Buffett and other selective contrarian investors (consistent, high returns on capital and equity in excess of 15%, coupled with comparably high, consistent operating margins which generate great amounts of free cash flow). Furthermore, the earnings of these companies are completely unpredictable. And I do not think that a major reorganization of either company will correct this flaw. In conclusion, the automobile industry is a highly unpredictable industry in which to invest if one seeks reliable, consistent returns on equity (the investor’s primary metric), compound earnings’ growth, and improvement in book value. I do not think that there’s any good reason for to invest in the common shares of any automobile manufacturer, at any price. Under the current market conditions I think that there are many, many other opportunities in which to invest capital at a much lower risk of permanent loss and with a higher, more predictable chance for capital gain which exceeds the historic average.
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It sole depends on what arena you want to step into..
I’ve been in this game a while and I’ve seen investors loose and win.
My suggestion is that you gear in towards the private sector with other investors
Im talking about private placements trade platforms. But be so very careful
because there’s so many ones that do not perform. I only know of 2 in the world that I’ve been a principal my self with beautiful returns better than your typical wall street trading situations.
If your interested I could get you on a conference with the trade platform manager.
of course Im direct. If your serious you could talk with the Trader with in days of you pursuing
into the platform.
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Jpe, hope you had a good break.
No matter how I look at it, GM is doomed to fail.
Completely disregarding the numbers and just by looking at the way they have been going about its business makes me scratch my head.
Why is it that US auto companies are reactive rather than proactive?
When everyone in the world is crying the fuel economic stylish cars, GM is trying to hype its Hummer franchise. We don’t even see too many gangster rappers rolling around in 25in rims anymore. Even they have changed style.
Compare the amount of R&D between Toyota and GM. That comparison says it all.
GM, but mostly GM management, has to wake up and realize that the American buyer and trend has changed.
Some may consider GM to be cheap, but bad management will make it cheaper until it’s so cheap it’s worthless.
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