Bright and early Friday morn, Canadian investment banker RBC Capital announced it is raising its rating on Ford stock from sector perform to outperform, and assigning the stock a new price target of $14 a share. Relative to its previous prediction, that's an 8% bump in target price. Relative to Ford's current stock price of $12.44, it promises as much as a 12.5% profit. Combined with Ford's beefy 4.8% dividend yield, that promises total profits of more than 17% by year's end.
Here are three things you need to know about the upgrade.
1. What Ford said
Ford had a rough year in 2016, with profits falling 38% to $4.6 billion despite a 1.5% rise in revenue. Ford's global market share declined in 2016 (down 10 basis points), as did its automotive operating profit margin (also down 10 basis points). And management told investors to expect continued declines in the new year, with sales, profit margins, and earnings all falling over the next 12 months.
2. Nobody but nobody loves Ford
As explained in a write-up this morning on TheFly.com, this has led analysts to bake in "low" expectations for Ford's future prospects. Analysts quoted on Yahoo! Finance now see Ford's revenue slipping by about 0.5% in 2017, with profits plunging 8.5% to about $1.63 per share.
As a result, though, says RBC, expectations for Ford stock are now so low that unless the company experiences a serious "macro shock" (which would treat rivals General Motors (NYSE:GM) and Fiat Chrysler just as harshly), there is little chance that Ford will miss estimates this year.
That makes $1.63 per share essentially a worst-case scenario, and RBC believes that as things stabilize, there's every chance analysts will begin raising estimates for Ford over the next few months -- creating catalysts for the stock to rise.
3. How cheap is Ford stock?
Hence the upgrade. As RBC points out, Ford stock has underperformed General Motors stock by 21% since September 2016. Priced at just 6.8 times earnings today, the stock looks cheap if Ford can resume growing earnings. And even Wall Street's "low" expectations for the company still forecast 15% long-term earnings growth rates for Ford, according to data from S&P Global Market Intelligence.
RBC says it's betting on Ford shares "closing the valuation gap" with GM. But how big is this gap, really?
The most important thing: Mind the gap
Ford's 6.8 times earnings valuation, weighed against its total expected return of nearly 20% (15% from earnings growth, plus the dividend of nearly 5%), results in a total return ratio of just 0.34 on Ford stock -- an incredible bargain if Ford can maintain the dividend, and deliver the growth that Wall Street is expecting of it.
In contrast, GM stock (which has not yet reported full-year 2016 earnings, but which is expected to report rising profits into 2017) sells for just 4.1 times its last-reported trailing-12-month earnings. Analysts only foresee 10% long-term earnings growth from GM, and the stock's dividend yield is only 4%. Still, with an expected return of 14%, that results in a total return ratio of 0.29 -- about 14% cheaper than Ford's ratio.
So does RBC's thesis that Ford stock is a better deal than GM stock hold water? I don't think so. On the surface, GM stock selling for 4.1 times earnings already looks a lot cheaper than Ford stock selling for 6.8 times earnings. Factor in a slower growth rate and a stingier dividend, though, and...GM still looks cheaper than Ford.
Mind you, I'm not saying that RBC is wrong to predict that Ford stock will outperform the market in 2017. To the contrary, at prices this cheap, I don't see how Ford can realistically underperform. But as for Ford having some big "valuation gap" with GM stock, and be fated to outperform its rival as well -- forget about it. The gap doesn't exist.