With everything from stock rebounds to product recalls, 2010 has already been an eventful year for auto stocks. But with all of that chatter in the auto industry, it's sometimes difficult to tell which stocks you should add to your portfolio - and which you should avoid. Here's a rundown of a few of the car stocks with the best potential for the year.
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Investors have been wise to avoid the autos for a few years. A highly publicized bankruptcy for General Motors last year was the final nail in the auto industry's coffin, following a long record of slumping sales that was exacerbated by a seized-up credit market. And Toyota's recall troubles sent an equally chilling signal in 2010, reminding investors that while sales numbers had perked up, there were still critical risks in the industry.

But while troubled stocks were faltering, some of the auto industry was actually thriving. As surprising as it may seem, 2008 and 2009 provided some automotive companies the opportunity to clean house and regroup - only to post solid numbers in the early part of this year. And perhaps more surprisingly, one of the brightest stars in 2010 has been an American automaker.

Dealing with Domestic Automakers

The automotive industry in the U.S. has seen its share of trouble for the last couple of decades, plagued by intense competition from foreign marquees and serious consumer satisfaction shortfalls, Detroit's "big three" automakers - GM, Ford, and Chrysler - have seen their market capitalizations dwindle in the 2000s.

Both Chrysler and GM filed for bankruptcy in 2009, resulting in the end of the latter's trading on the NYSE (Chrysler was already a privately-owned company). But the company that remained unscathed was Ford.

Ford benefited from being the "best of the worst" but new direction could mean that Ford will see long-lasting operational advantages. The company is already doing a good job of proving its ability to produce quality vehicles (one of the reasons its Focus compact continues to be one of the top-selling cars in Europe). Ford's mainstream Focus and Taurus lines were redesigned to compete with highly economical Japanese offerings, and its 2011 Mustang has already left gear heads drooling: the new model offers significantly more horsepower than current iterations.

Shares have moved in kind, rallying more than 200% in the last 12 months. Although debt continues to be a problem for automakers, Ford's balance sheet is improving quickly and other auto bankruptcies should give the company extra bargaining power with unions. As Ford continues to trim its expenses and build cars that consumers will fawn over, the company should see margins improve in 2011.

Have Foreign Car Stocks Lost Their Luster?
Toyota's costly recalls have left a huge blemish on foreign automakers. Once thought to be beyond reproach from a quality, efficiency and ethical standpoint, revelations about the best-selling automaker dragging its heels on recall status continue to unfold.

And they continue to cast a shadow on the stock - dragging it double-digits below market averages year-to-date. (For more, see Recall Recoil: Will Toyota Recover?)

One of the biggest beneficiaries should be fellow Japanese rival Honda Motors, which enjoys one of the most value-retaining car fleets in the world right now. Honda's carving out a high-margin niche in the hybrid market, and it does so with relatively low labor input costs - but a strong yen could undercut profits given the U.S.'s positioning as the largest auto market in the world.

More interesting automobile plays are coming from the emerging market, where companies like India's Tata Motors and China's Geely Automotive are taking advantage of deflated equity prices to snatch up bargain-priced premium brands like Range Rover and Volvo.

While many of the best foreign automakers are difficult to invest in because they lack decent trading volume or ADR issues, their suppliers or U.S. dealers provide an easy point of access. Penske Automotive Group and China Automotive Systems are just two examples of back door foreign car plays.

Know the Cycle
Because the auto industry is largely cyclical, it's prone to boom and bust economics. Even so, with consumer credit and spending both on the upswing in 2010, there's ample opportunity to take advantage of the cream of the automotive crop. Here's to a clear road ahead this year for the auto industry. (To learn more, check out Analyzing Auto Stocks.)

Check out last week's business highlights in Water Cooler Finance: My iPad Beats Your Toyota.

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