The automotive industry consists of many companies that span the globe, with a total value of $2.7 trillion. The industry includes not only the major auto manufacturers but a variety of firms whose principal business is related to the manufacturing, design, or marketing of automotive parts or vehicles.
Since these companies make similar products and share the same market niche, financial experts use a variety of metrics to compare individual firms in the industry. This allows them to determine the level of their performance in relation to their peers.
Some of the most critical financial ratios investors and market analysts use to evaluate companies in the auto industry include the debt-to-equity (D/E) ratio, the inventory turnover ratio, and the return on equity (ROE) ratio.
- The automotive sector is one of the largest industries in the world, with an estimated $2.7 trillion of global commercial activity.
- Financial analysts use a variety of performance metrics to compare different firms with their competitors.
- The debt-to-equity ratio measures a company's financial health and ability to repay its creditors.
- Inventory turnover represents how quickly a company can sell vehicles and serves as a warning sign if sales fall.
- Return on equity is a generalized metric for profitability, indicating how much shareholders get back on their investment.
Auto Industry Overview
The United States alone has 16 auto manufacturers that, together, produced almost 9.2 million vehicles in 2021, the bulk being from the "big three" car manufacturers. The most important part of the industry is the manufacturing and sale of automobiles and light trucks. Commercial vehicles, such as large semi-trucks, are an important secondary part of the industry.
Another essential aspect of the auto industry is the relationship between major auto manufacturers and the original equipment manufacturers (OEM), as the major automakers do not actually manufacture the bulk of the parts that go into an automobile. The global auto industry is capital-intensive and spends more than $120 billion annually on research and development (R&D).
The automotive industry constitutes one of the most important market sectors. It is one of the largest sectors in terms of revenue and is considered a bellwether of both consumer demand and the health of the overall economy. Historically, the industry tends to account for around 3% of U.S. GDP. Analysts and investors rely on a number of key ratios to evaluate automotive companies.
The number of vehicles the United States produces annually.
Key Financial Ratios
The following are the most important financial ratios that investors and analysts look at when evaluating the auto industry.
Because the auto industry is capital-intensive, an important metric for evaluating auto companies is the debt-to-equity ratio (D/E), measuring a company's overall financial health and its ability to meet financing obligations. An increasing D/E ratio indicates a company is being increasingly financed by creditors rather than by its own equity. Therefore, both investors and potential lenders prefer to see a lower D/E ratio.
A D/E ratio of 1 indicates a company whose assets and liabilities are equal. However, it's important to compare D/E ratios to companies within the same industry, as different industries have different debt requirements.
The average D/E ratio is typically higher for larger companies and particularly for more capital-intensive industries, such as auto manufacturing. As of the first quarter of 2022, General Motors reported a debt-to-equity ratio of 1.768. The figure for Ford was 3.010 and the ratio for Stellantis was 0.556.
Alternative debt or leverage ratios that are often employed to evaluate companies in the auto industry include the debt-to-capital ratio and the current ratio.
Inventory Turnover Ratio
The inventory turnover ratio is an important evaluation metric specifically within the auto industry to auto dealerships. It is usually considered a warning sign for auto sales if auto dealerships begin carrying substantially more than about 60 days worth of inventory on their lots.
The inventory turnover ratio calculates the number of times in a year that a company's inventory is sold, or turned over. It is a good measure of how efficiently a company manages ordering and inventory, but more importantly for car dealerships, it is an indication of how rapidly they are selling the existing inventory of cars on their lot.
The average inventory turnover ratio was 10.11 for the first three months of 2022. In other words, the average car manufacturer had sold through its entire inventory just over ten times over the previous twelve months.
Alternatives to considering the inventory turnover ratio include examining the days sales of inventory (DSI) ratio or the seasonally adjusted annual rate (SAAR).
The average price increase for used cars during the COVID-19 pandemic.
Return on Equity Ratio
The ROE is a key financial ratio for evaluating almost any company, and it is certainly considered an important metric for analyzing companies in the auto industry. The ROE is especially important to investors because it measures a company's net profit returned in relation to shareholder equity, essentially how profitable a company is for its investors.
Ideally, investors and analysts prefer to see higher returns on equity. The industry average was 15.86% for the first three months of 2022.
Along with the return-on-equity ratio, analysts may also look at the return on capital employed (ROCE) ratio or the return on assets (ROA) ratio.
Which Financial Ratios Are Important for the Automobile Industry?
In addition to the financial ratios listed above, there are also some metrics that are specific to the auto industry. For example, the utilization rate represents how effectively a company is using its production capacity, and the downtime rate indicates how often a company has to shut down its facilities for maintenance and repairs. The yield rate indicates the percentage of cars that meet a company's specifications, and the recall rate tells you how many of those vehicles are not satisfactory.
What Is a Good ROA for the Automotive Industry?
The average return on assets (ROA) for companies in the automotive industry was 3.87% in the first quarter of 2022, down from 6.04% for the three months prior. Any company with a higher figure can be considered relatively profitable compared to its competitors.
Is the Automobile Industry Capital-Intensive?
The auto industry is considered extremely capital-intensive, because of the high capital costs for companies in the industry. Property, plants, and machinery take up large shares of the company's expenditures compared to the costs of labor or raw materials.
What Is a Good Profit Margin in the Auto Industry?
The average net profit margin for the auto industry was 7.5% in the five years before 2020, with most companies scoring at least 4%. Generally, premium brands tend to be more profitable. The lowest profit margins were from Tesla, at -11%.
The Bottom Line
It's important to take a look at many financial ratios to gain an overall idea of how a company is performing. The three ratios discussed here are important in the auto industry and provide a good indicator of how a company is operating. However, to gain a better understanding of a company, one needs to consider its specific dynamics as well as other metrics to determine its true financial health.