Why GM's Not A Value Trap

By Will Ashworth | September 25, 2011 AAA

Do you rely on the price-to-earnings ratio? Investors who use the P/E ratio to gauge a company's valuation run the risk of buying into a value trap, a point at which a stock trades at a multiple somewhere below 10 times earnings. Enticing for sure, you always should ask yourself why this is. It might be that the company has no future, or it could be that investors just don't buy its growth story. Whatever the reason, a low P/E ratio is not always a sign to buy. General Motor's (NYSE:GM) P/E ratio, as of September 26, is under five. Some doubt its ability to thrive long-term; I have no doubts. Here are three reasons why GM's stock isn't a value trap. (To read more on value traps, see Cheap Stocks Or Value Traps?)

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Labor Peace
Until the car companies can figure out how to make vehicles without humans or the United Auto Workers decides to fold up its tent and go home, labor negotiations will likely continue to be a part of the North American automobile industry indefinitely. A good labor situation, whether you're unionized or not, is critical to any company's success. The tentative labor deal GM reached with the UAW sends a signal to all its competitors that GM and its employees are on the same page.

Ford (NYSE:F) and Chrysler will likely follow suit with similar deals, so GM's ultimate advantage is muted. But that's okay. At this point in its resurrection, it simply needed to get a deal done that's good for everyone. The base hourly wage of new workers will go from $14 today to $19 by the end of the contract. Although all existing workers get $5,000 signing bonuses and better profit sharing, none will get raises, not even cost of living increases. In return for these concessions, GM will hire approximately 6,400 new entry-level workers over the next four years, spending $2.5 billion on its plants in the U.S. between now and 2015. As its workforce continues to get younger, its production costs will drop. That's a good thing for everyone. The union gets more jobs and a bigger piece of profits, and management gets cost certainty on its expenses. Ultimately, shareholders win.

Beautiful Cars
I've never been a fan of GM cars. They've always seemed to use too much chrome, but things are definitely changing. First it was the Malibu, introduced in 2008 and due for a redesign in 2013. Then it was the Chevrolet Cruze, which won all sorts of car-of-the-year awards in 2011. And just yesterday, a 2012 Buick Regal GS flew past me looking very nice and extremely agile. Cynics will always question GM's quality, but anyone who's driven a Honda Civic lately knows the Cruze is a much better vehicle. Frankly, GM should be focusing more of its attention, especially when it comes to small cars, on Hyundai. According to Kelley Blue Book, in the second quarter of this year Hyundai became the No.1 car brand for loyalty. Approximately 52% of Hyundai owners are looking to buy another one when they next purchase a car. GM has a long way to go to get to those numbers, but it's definitely more realistic today than three years ago.

General Motors and Peers

Company Price/Cash
General Motors (NYSE:GM) 1.00
Ford (NYSE:F) 2.19
Toyota Motor (NYSE:TM) 2.59
Honda Motor (NYSE:HMC) 3.28
Tesla Motors (Nasdaq:TSLA) 8.31

Future Earnings
We're getting close to the one-year anniversary of GM's IPO at $33. It's lost 36.4% of its value since November 18, 2010, with most of the decline since the beginning of the year. While its stock's headed south, its financial situation has gotten much better. Analysts estimate it will generate $149 billion in revenue in 2011 and net income of $6.7 billion. Revenues are about equal to where they were in 2008. However, back then it lost $31 billion, so from a glass half-full perspective, business is definitely better. Sure, revenues aren't over $200 billion as they've been in the past, but business is about making money, and they're doing it.

If you look at Toyota's revenues and net profits from the past decade, arguably one of the world's most profitable car companies up to 2008, its best year for revenue and net income was 2008 with $261.1 billion and $17.1 billion, respectively. That's a net margin of 6.5%. Toyota's best year in terms of margin was 2007 at 6.9%. GM's net margin in 2011 is expected to be 4.5%, only 240 basis points shy of Toyota's best year.

With the labor agreement in GM's hip pocket, there's no reason it can't nibble away at the difference. Moody's recently indicated that it might upgrade GM's credit rating due to its financial success and the potential labor deal. A higher rating translates into a meaningful reduction in its borrowing costs. Yet its stock trades at 1 times cash compared to an average of 4.1 times for four of its biggest competitors. That's the definition of insanity.

The Bottom Line
While GM's future is unknown, it's much brighter than when it emerged from bankruptcy in July 2009. At this point, its $33 IPO price appears more than fair value. (To learn more about corporate bankruptcy, check out An Overview Of Corporate Bankruptcy.)

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