Kicking The Tires

Tire producers have been performing well lately. Since April, Goodyear (GT -1.59%) is up 57.7%, while Bridgestone, (BRDCY -0.60%) is up 40% YoY. Germany's blue-chip index, the DAX, gained 29% in 2012; a company that receives approximately 30% of its revenue from selling tires, Continental AG, (CTTA.Y -1.38%)  gained 82% that year and was the index's best performer. Buying any one of these stocks six months ago would have produced solid results.

Are they cheap based on past averages?

All three companies have long histories. Bridgestone, the youngest, is 82 years old, while Continental and Goodyear both began doing business in the 19th century. All three companies also appear expensive relative to their profits from the past few years.

*Using 3 year average normalized, diluted earnings

While it isn't a perfect indicator, a company's price relative to its 3 year average diluted net income can still be very informative. A P/E ratio of over 25 doesn't always signal an expensive stock. But suppose a company has barely been growing revenues for the past 4 years, with margins under 10%. Buying a company with low margins, low revenue growth, and a P/E ratio over 25 doesn't usually produce great results.  

How do the balance sheets look

An exceptional amount of balance sheet value could still make one of these companies a solid buy at current prices--but do any of these companies have that?

Goodyear's massive $6.53 billion debt load is equal to 142% of its market cap. Said debt is also far larger than Goodyear's sliver of equity, which would not exist without its intangible assets. Goodyear may have the lowest P/E ratio of this group, which is still pretty high, but it has the lowest margin by far, and its balance sheet is by far the weakest.

Continental is very expensive relative to its tangible book value, although the company isn't overburdened with debt. It isn't a bad buy based on its high tangible book ratio alone, though.

With the lowest debt to equity ratio and the most tangible book value per share, Bridgestone has the strongest balance sheet among these companies. The difference between Bridgestone's equity, which includes $400 million of intangible assets, and its market price is still $10.8 billion.

What's the potential for earnings growth

At Bridgestone and Goodyear, tire sales comprise 84% of revenues. Sales declined between 2010 and 2012 in all four of Goodyear's major geographical segments. Bridgestone also has four geographical segments--since 2010 the company's domestic sales have been relatively flat, sales in Europe have surprisingly not declined, and sales to the Americas have increased slightly.

Bridgestone managed to grow revenues by 14.5% between 1H 2012 and 1H 2013, and also grew net income by 56% during that period. The company's CEO believes the tire market will only continue to become more fiercely competitive, putting pressure on the company. Bridgestone does have the best margins and sales among tire-makers. Recent results suggest the company will maintain that status.

Continental differs from the others in that it isn't primarily a tire company--tts revenue is fairly evenly spread out across five different business segments. Continental provides a wide range of products for users of automobiles. It provides safety with products like electronic brakes and airbag control systems. The company also produces engines and sound systems.

Being a company that derives 55% of its sales from Europe, Continental's results have been hampered by the economic woes of the Euro Zone. Despite the instability of the company's most important market, it still expects larger revenues in 2013 than in 2012. The company still has confidence it will achieve its 2012 goals for EBITDA margins, free cash flow, and sales.

Foolish final thoughts

Out of these three companies, two appear decent while the other appears to be a bad investment. Compared to its peers, Goodyear has an incredibly weak balance sheet and the lowest margins. Goodyear also has negative tangible book value. Those are terrible characteristics for any investment.

Bridgestone has low levels of debt, excellent margins compared with other tire makers, and a solid amount of tangible value on its balance sheet. These are tumultuous times for tire producers, and in the short term Bridgestone will undoubtedly experience setbacks. However, Bridgestone has a solid amount of tangible book value on its balance sheet and the best margins in the business.

Continental is a diversified company that provides a variety of products to the automotive industry. The company is incredibly expensive relative to the tangible value on its balance sheet, and has an unhealthy working capital deficit. Continental grew sales at a 7.8% rate over the past four years while improving margins across multiple segments. This is a high quality company that was one of Germany's best performing stocks in 2012 for a reason.