Despite PER 5.7: This stock is not a value opportunity

In the pursuit of returns in the stock market, cheaply priced value stocks can provide an opportunity. Namely, when the low valuation turns out to be unjustified and the price-earnings ratio (P/E) rises as a result. On the other hand, there is of course the risk of falling into a value trap. In this case, market participants expect future profit losses. When corporate earnings fall, the P/E rises, but the share price has not budged.

Mercedes Benz (WKN: 710000), Volkswagen (WKN: 766403) and bmw (WKN: 519000 ) currently all have very low P/E ratios. The Swabians are still the most expensive with a price-earnings ratio of 5.7 (as of 2 September 2022). This actually means offer notice in all other industries. Only when it comes to auto stocks, no one really wants to buy. Is this an opportunity for value investors or is a value trap closing in?

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Why auto stocks are traditionally cheap

In some sectors, such as software or technology, high P/E ratios of 20 and above are the order of the day. Auto stocks, on the other hand, tend to hover in the single digits. What is driving this apparent valuation of share prices?

First, the automotive industry is extremely capital intensive. A car manufacturer has to invest huge sums of money in gigantic production facilities so that even a single vehicle can roll off the assembly line. A software company can be started with a few mouse clicks, and a computer program can be duplicated without much effort.

This is expressed in a ratio called capital turnover, which compares sales to a company’s total capital. Mercedes-Benz experienced a stellar 2021 fiscal year, but still only generated slightly more than half of its total assets. The capital turnover was 51.5%. Apple as a representative of the tech industry managed a more than twice as high capital turnover of 104.2%.

And further?

On the other hand, competitive pressure in the automotive industry is extremely high. This makes it difficult for many auto stocks to charge high prices for their vehicles and achieve higher profit margins. Compounding the problem is that a car is an extremely expensive purchase for a customer.

This difference compared to other industries can best be seen in the return on invested capital. Here, the operating result is divided by the long-term invested capital. Mercedes-Benz achieved a return on equity and debt of 9.3% in 2021, while Apple is in a completely different league with a return on capital of 48.3%.

The return that investors get on their invested money has a significant impact on the company’s value. So it’s no surprise that auto stocks regularly have lower P/E ratios than other stocks. So this has nothing to do with a cheap valuation, but simply reflects an efficient market.

The perfect storm: Here’s why auto stocks are cheap right now

But even compared to historic lows, auto stocks look pretty cheap right now. They recently achieved record profits. How does it add up?

The stock market is looking to the future and has realized that record gains are unlikely to be sustainable. In recent quarters, car stocks have benefited from high demand, which was met by limited supply due to the shortage of chips. Automakers preferred to put the scarce chips into expensive, profitable models. They also had to give fewer discounts and benefited from less competitive pressure.

But now the shortage of chips is gradually disappearing, and many customers are still waiting for their entry-level models. Car manufacturers will once again be able to utilize their production capacity more efficiently, which will boost sales, but also increase competitive pressure. At the same time, the shift to electromobility and the increasing importance of software require billions in investment with no prospect of guaranteed success.

It shouldn’t surprise anyone if automakers’ profits fall next year. This will also push car stock valuations higher again – without the share price having to rise at the same time. That really doesn’t sound like a value option.

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Christoph Gössel owns none of the shares mentioned. The Motley Fool owns shares in and recommends Apple and Volkswagen AG. The Motley Fool recommends BMW and recommends the following options: long March 2023 $120 calls on Apple and short March 2023 $130 calls on Apple.

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