If someone handed you a nice, crisp $100 bill and told you to pick an automotive stock to invest in, what companies would come to mind first? Your first instinct may be to choose an auto manufacturer -- but what if you have concerns about the individual brands, the brand you're interested in isn't a public company, or you want to invest in more than one? Automotive dealer groups steer your portfolio through the revitalized auto market, avoiding the potholes caused by investing solely in automakers.
Let's take a look at three advantages of investing in auto-dealer groups, which could allow you to capitalize on the rebounding auto market without putting all your eggs in one basket. State franchise laws prohibit manufacturers from owning and operating dealerships, providing a great opportunity for others to enter the automotive business without having to develop their own products. Though the majority of the 17,725 dealerships in the U.S. are local mom-and-pop shops, or larger private groups, several public automotive dealer groups operate franchised dealerships across the country, allowing you to invest in multiple brands by proxy.
Mix it up a bit
With sales returning to pre-recession levels across the (dash)board, investing in individual automaker stocks will limit your ability to cash in on the marketwide trend. By choosing an automotive dealer group such as Penske Automotive Group (NYSE:PAG) or Asbury Automotive Group (NYSE:ABG), you are able to capitalize on the increased sales across brands. Likewise, if one brand is struggling and sales are redirecting to another, dealer groups (and you) can continue to profit on that U-turn because of the built-in cushion provided by their brand diversification.
Dealer groups also allow your investment to act as an index of sorts -- since each dealer group has a different franchise mix, you can choose between them based on your preference of brands. For example, Sonic Automotive (NYSE:SAH) is largely focused on import and luxury brands, while Lithia Motors (NYSE:LAD) is heavily concentrated in domestic brands. Since many of the luxury brands aren't publically traded companies, dealer groups can provide investment opportunities not found elsewhere.
Unlike the growing pains experienced by automakers expanding in foreign markets, dealer groups focus primarily on sales in the U.S., causing less disruption in operations. Two exceptions to this rule are Penske and Group 1 Automotive (NYSE:GPI), which both operate dealerships in Europe.
On the flip side, the companies face geographical influences that can disrupt business; a recent example would be the damage to 12 of Group 1's dealerships caused by Hurricane Isaac in September. Closures related to the hurricane interrupted sales during a crucial time of year for the automotive industry (dealers experience the same cyclical and seasonal sales fluctuations as automakers).
Mo' money... less problems?
Dealership operations have an inherent advantage over manufacturers with embedded revenue generators beyond vehicle sales. Income producers -- such as service operations, aftermarket accessories, protective packages (anti-scratch paint coatings, etc.), and extended warranties -- boost dealership bottom lines even when vehicle sales are down.
Automotive service, in particular, helped support automotive dealers throughout the recent downturn. Since consumers were not purchasing new cars and, in turn, driving their cars longer, they spent more on repairs and preventative maintenance to keep their wheels-a-turnin' -- a revenue stream the automakers couldn't cash in on.
Public automotive dealer groups have consistently outperformed the S&P 500 since November 2010, while automakers have been inconsistent during the same time frame:
Auto dealers experienced the same downturn in operations as conventional automakers did, but enjoyed a quicker turnaround since they are the first stop for incoming cash from consumers returning to the market.
This year's hottest model
One of the strongest dealer-group companies, Penske, has continued to expand its dealership network and operations, while maintaining healthy earnings and margins. The company benefits from strong leadership by Roger Penske, Sr.; a geographically diverse portfolio of dealerships; and a heavier concentration in import and luxury brands. Investors benefit from Penske's $0.48 per share dividend (payout of 17% over the trailing 12 months), which signals the company's strong balance sheet despite the inherently cyclical nature of the automotive industry.
By expanding your scope of auto stocks to include automotive dealer groups, you can put some more air in your portfolio's tires with the industry's continuing recovery.
Fool contributor Jessica Alling has no positions in the stocks mentioned above. The Motley Fool owns shares of Asbury Automotive Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.