One of the most important concepts in finance is that of cycles. The idea is that there are ups and downs in any sector, asset class, or other type of market activity. While some investments go to zero, many simply rise and fall within a certain range for a fixed period of time as a result of external changes that impact the company. But even those investments will one day break through that range to the upside or downside, either seeing a new range or finally falling to zero.
No clearer instance of this tendency is there than automobiles. Car sales have a cyclical nature. This intuitively makes sense; people buy a car, keep it for a long period of time (5-15 years in most cases), and then buy a new one. If there are clusters of buyers that buy more often in one particular year and less in another, and if buyers tend to keep a vehicle for a fixed period of time, you’ll have steep peaks and valleys in car sales that will be noticeable among automotive companies.
This trend has been noticeable among car markers Ford (F), General Motors (GM), and Toyota Motors (TM) since the 2008 financial crash. After a steep slump from the market crash, shares in these firms soared to pre-crisis levels faster than many other industries (Ford was back to pre-crash levels in early 2010, while the market didn’t get there until 2011). But then sales weakened in 2011-2012 and the stock fell again, still staying above its pre-crisis level.
Then 2013 saw a surge, partly a result of quantitative easing but also largely a result of the cyclical nature of car sales. The stock soared to reach its early 2011 peak and stayed at that level until mid-2014, when it began to fade. It’s been fading since then, and is only marginally above its pre-crisis level.
Why is this? There’s no fundamental change in F’s marketing strategy or offerings; its net profit margin has risen to exceed 4% and its P/E ratio has stayed low, now below 12. Its dividend has continued to grow as well since being suspended in the mid-2000s and restarting in 2012.
The real reason is in Wall Street’s fear that recent declines in auto sales will be part of a long term trend. One sees these fears in mainstream financial publications all the time. A common trope is that Millennials aren’t buying cars because they don’t like them, they’re moving to dense cities, or they just don’t have enough money to buy a car. Then you see another doomsday scenario played out in other articles, where subprime auto loans are going to start a new financial crisis.
These are all hyperbolic overstatements of a key observation: car sales have peaks and valleys. In 2013 we were at a peak, and now we’re at a valley. A close analysis of car sales can give analysts a sense of when the next peak will be, and a discounted cash flow model can tell analysts what stock price is ideal to buy during this moment of bearishness in anticipation of future bullishness.
Of course, that’s a hard thing to do during a panic, and we’re in a rare market moment where there’s broad celebration except in the auto vertical, where there is serious panic. Ford saw unit sales fall 7.1% in the U.S. and GM saw sales fall 5.8%. Both were far worse than analyst expectations. Already the mainstream press is talking about a 2007-like moment for auto stocks, and the sense of a major crash coming. (Of course, there weren’t so many bearish warnings during 2007, already telling us the metaphor is wrong).
Auto stock analysis is not one of the most exciting or prestigious corners of finance, but massive alpha can quickly be earned from this sector as a result of that mainstream apathy. Analysts who can calculate the time and level when auto stocks are undervalued due to recency bias can also make market-winning bets and recommendations that can make careers and yield massive bonuses, as well as alpha for clients. And in doing so, they can turn the boring into a big money maker—which is something no one finds boring.