Dueling Fools

Dueling Fools

GM Tough
Bull Argument

By Paul Larson (TMF Parlay)
October 13, 1999

I think we all know who General Motors is, so let's get right to the punch. At today's prices I think GM's stock represents a good value. GM is not exactly a growth company, but mature companies can make for good investments, too. They can make for especially good investments when the price is right, which appears to be the case with General Motors.

The company is expected to earn $8.14 per share in 2000, and some analysts think as much as $9.00 per share is realistic. That means that as of this writing the stock is trading at about 8x forward estimates. For reference, the S&P 500 is trading near 24x forward earnings. The stock also has a dividend yield near 3%, which is roughly triple the S&P 500 average. By just about any valuation yardstick you use, GM is cheap.

You can also see just how inexpensive GM is by looking at its sales relative to its stock price. GM is the largest company in the nation on a revenue basis with $168 billion in trailing annual sales. Nevertheless, Wall Street is valuing GM, including its debt, somewhere near $60 billion. Compare this to Microsoft, which has $20 billion in trailing sales and a market capitalization approaching $500 billion. Of course, Microsoft is in a much better strategic position and deserves higher valuation multiples, but should there really be a 70-fold difference in price-to-sales ratios?

From an operational standpoint, I also like what I see from GM. The company has recently been focusing on profitability instead of market share. GM has also followed the industry trend toward consolidation and is in the process of reducing the red tape from its mega-bureaucracy. These are both factors that are giving a turbo boost to the bottom line and should, eventually, accelerate the stock northward.

Over the years, GM has been increasing its top line while reducing headcount, greatly improving profitability along the way. Back in 1987 the company had $102 billion in sales and 813,000 employees. Today, it has $168 billion in sales and roughly 580,000 employees. That means revenue per employee has gone from about $125,000 to near an eye-popping $290,000. Between productivity improvements and cutting fat from the organization, GM's operations, like its engines, are getting more efficient all the time.

The company also has an inherently better product mix these days in an intentional strategy to concentrate on trucks. Trucks and sport utility vehicles (SUVs) are what some watching the company describe as vehicles with "better structural profitability." In other words, each truck and SUV sold carries a much higher gross profit than a typical sedan. In the most recent quarter, the company actually produced more trucks (775,000) than it did cars (760,000), and continued growth in the truck and SUV business is expected.

GM also has several divisions outside of its core automotive business that are quite attractive. One of the most attractive is Hughes Electronics (NYSE: GMH), operator of the wildly popular DirecTV service. I've been a DirecTV subscriber for about three years now, and I love the service as much as when I first signed up. With Hughes recently teaming up with AOL to ramp up the rollout of high-speed Internet access via Hughes' satellite system, GM, in a tangential sort of way, is set to benefit from the Internet. A more direct way the Internet may help GM is in the way it sells and distributes vehicles. Its GMbuypower.com website gives an interesting glimpse of things to come from Detroit.

Finally, I would be remiss if I didn't mention that GM is today a member of the Foolish Four. Historically, companies that end up on the list tend to outperform the market averages over the following 12 months. GM is the quintessential Fool Four pick today since it is a huge company that is not going out of business. However, the market has already priced into the stock more than its fair share of skepticism.

Those looking for an inexpensive large-cap stock to add to their portfolio should definitely kick GM's tires. The company is leaner, meaner, and more profitable than it has ever been. But more importantly, one doesn't exactly get sticker shock when looking at the stock's price.

Next: The Bear Argument