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1 Surprising Dividend Stock to Watch

By John Rosevear - Oct 27, 2017 at 6:04AM

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It’s an automaker, but this isn't the usual story.  

A lot of investors have a tough time with auto stocks. But here's a tip: One thing I've learned after years of watching automakers is that a strong positive change in product direction is often followed by increases in both sales and profitability. When that happens, the stock price usually follows. 

What does that mean? Think about how Ford Motor Company's (F 1.71%) products changed from 2005, before CEO Alan Mulally joined the company, to about 2014, when Ford's Mulally-driven product revival was more or less complete. 

In 2005, Ford's small and midsize sedans were mostly so-so products that had to be discounted to sell. If they were profitable at all, those profits were tiny. But by 2014, Ford had launched all-new versions of the Fiesta, Focus, and Fusion -- and they were hugely improved. 

Those new models were all excellent entries that drew new buyers to the Ford brand. And importantly, because they were were so well-regarded, they sold with minimal discounts and thus generated more profits per sale. 

Simply put, in the auto industry, more desirable products lead to fatter profits, because both total sales and pricing improve. And here's the thing for investors: If you were watching carefully, Ford's product renaissance was visible a few years before those cars were launched. If you were watching carefully, that was a buy signal. 

Got it? Lesson over. Now, let's talk about Honda (HMC 0.25%).

Hachigo is shown standing next to Honda's Urban EV Concept on Honda's auto-show stand in Frankfurt in September 2017.

CEO Takahiro Hachigo has put Honda's focus back on great products. The results are starting to show. Image source: Honda Motor Co., Ltd.

Why Honda could be the next product-driven-growth story

When Takahiro Hachigo became Honda's new CEO in 2015 after a series of uncharacteristic quality stumbles, he promised to refocus the company on creating great products

I plan to create a new Honda. Rather than focusing on numbers, it is important to come up with products that carry dreams and satisfy our customers. We will focus on the development of innovative products.

Back in the 1980s and 1990s, Honda drew legions of fans with consistently innovative, desirable products. But by 2015, there was a sense among fans and industry watchers that Honda had lost its way, that its once-great products had become merely good.

Now, in 2017, we're starting to see signs that Hachigo's promise was much more than talk:  

  • Honda's compact Civic was given a big power boost and an edgy new design for 2016. Critics weren't sure what to think, but Honda was on to something: Through September, it's the best-selling car in America this year.
  • The design of Honda's all-new 2018 Accord isn't quite as edgy as the Civic's, but it's sleek and upscale and far from the milquetoast looks of the Accords of recent past. And there's another flash of old-school Honda brilliance: An optional manual transmission, a rare feature on a family car in 2017 -- but to some buyers, a compelling offer. 
  • Honda could have done a me-too product for its first affordable long-range electric car. But instead, it reached way back into its history to create a concept vehicle inspired by its fondly remembered Civics from the 1970s. The concept (shown with Hachigo in the photo above) won many fans around the world; Honda may have yet another hit on its hands when the production version launches in 2019. 

Long story short: It's still early days, but your humble Fool, who has been watching automakers rise and fall for many years, thinks these latest products are signs that Honda's product mojo is on an upswing. That in turn suggests that Honda could see some nice profit growth over the next several years.

But is Honda's stock a buy right now? Let's take a look.

A close-up of the gearshift in a 2018 Honda Accord fitted with the optional 6-speed manual transmission.

When's the last time you saw one of those in a midsize family sedan? In a move that recalls the sporty flair that drew so many buyers to past Hondas, Honda is betting that an optional manual transmission will draw buyers who might not have otherwise considered an Accord. Image source: Honda Motor Co., Ltd.

How does Honda's valuation compare? 

As you can see, Honda's American depositary receipts (ADRs) are up about 3% over the last year, but it has been quite a bouncy ride. 

HMC Chart

HMC data by YCharts.

Like many Japanese companies, Honda uses a fiscal year that begins on April 1, and it reports its results in yen. In the fiscal year that ended on March 31, 2017, Honda earned 342.10 yen per share. Honda's shares are currently trading at a little over 10 times that in Tokyo, so it has roughly the valuation we'd expect for healthy automaker. (Translating everything into U.S. dollars doesn't meaningfully change the calculation.) 

That's a little steep compared to some rivals. General Motors, another healthy company on a product upswing, is trading at just 7.9 times its 2016 earnings, and tech-savvy Mercedes-Benz parent Daimler AG is in similar territory, with a price-to-earnings ratio around 7.6. 

A gray 2017 Honda Civic, a compact sedan.

Honda gave its Civic more power and a flashy redesign for 2016. It worked: So far in 2017, it's the best-selling car in America. Image source: Honda Motor Co., Ltd.

Like GM and Daimler, Honda does pay a decent dividend, yielding about 2.8% at current prices. And while it's a Japanese company, it's not hard for an American investor to own: Its ADRs are traded on the New York Stock Exchange, and Honda reports its financial results in English. 

But with the U.S. new-car market likely past the peak of its cyclical cycle, and with Honda forecasting a 11% decline in profits for the current fiscal year (on unfavorable exchange-rate moves and an increase in research and development spending), I'm thinking that Honda's shares might be a little expensive right now.

I think they're worth keeping an eye on, though, because Honda is looking more and more like a company that's headed in the right direction. 

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Stocks Mentioned

Honda Motor Co., Ltd. Stock Quote
Honda Motor Co., Ltd.
$24.21 (0.25%) $0.06
Ford Motor Company Stock Quote
Ford Motor Company
$11.32 (1.71%) $0.19

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