U.S. automaker Ford Motor Company (F 0.17%) has been viewed as a dinosaur by the growth investing crowd for many years, and the stock price reflected that attitude for most of the decade. But the share price has soared by more than 140% over the past year. With such an elevated valuation, investors might be wondering whether it's about to come back down to earth, or if more good times are ahead.
If electric vehicle (EV) leader Tesla's premium valuation is any indication, investors could see more gains from Ford. Here are three reasons why.
Image source: Getty Images.
1. Ford has gotten serious about electric vehicles
It's probably fair to say that legacy automakers were skeptical of EVs back when Tesla was a young, struggling company. Their delayed response helped Tesla build a significant lead in electric, and now many formerly skeptical competitors are scrambling to catch up. Globally, automakers could spend more than $500 billion by 2030 to ramp up their all-electric offerings.
Leadership in the automotive industry could be determined by how well the legacy automakers adapt to compete with Tesla. One thing that Ford deserves credit for is how seriously it has taken the challenge of the EV transition. It's throwing its two most valuable brands at it, turning out electric Mustangs and F-150 pickups.
Ford is still in the early stages of its transformation, but its momentum seems solid. It delivered 27,140 Mustang Mach-E models in 2021, and in 2022 will begin deliveries of the F-150 Lightning and the electric version of its popular Transit van. Investors will want to monitor how its electric models sell in the coming quarters and years, but Ford's muscular push is a welcome sign.
Financial similarities to Tesla
Tesla's work in autonomous driving and its reputation for putting cutting-edge technology into its vehicles have earned it a narrative as a technology company almost as much as an auto manufacturer. However, to make Ford's case, the financials between the two are more similar than one might expect.
As the first chart below shows, Tesla does indeed operate at a higher gross profit margin than Ford. However, if you look at the free cash flow each generates from its revenue, they are on relatively equal ground.
F Gross Profit Margin data by YCharts
How can this be? Consider that Tesla's a younger company and investing heavily in expanding its manufacturing capacity, building Gigafactories in Germany and Texas. Ford doesn't have those expenses to the same magnitude -- it has already built the factories it needs.
F CAPEX To Revenue (TTM) data by YCharts
Ford will, however, have to invest in converting that production capacity to build electric vehicles rather than internal combustion models. Still, you can see from the chart above that Ford spends mid-single-digit percentages of its revenue on capital expenditures like factories and equipment, while Tesla spends more than 15%. This is an advantage for Ford that I think is under-appreciated by many investors.
Ford's valuation has room to run
I'm not here to argue that Ford is more innovative or faster-growing than Tesla, because I don't believe that to be the case. What I am saying is that the gap between them isn't as big as some make it seem, and this is important when you look at valuations.
The consensus among analysts is that Tesla will report earnings per share (EPS) of about $6.29 for 2021, and that its EPS will grow at an annualized rate of 38% for the next three to five years. The stock's price-to-earnings ratio currently is 163.
For Ford, analysts expect earnings per share of $1.89 for 2021, and they expect that its EPS will grow at an annualized rate of 25% for the next three to five years. The stock's current P/E ratio is just under 13. In other words, Tesla's valuation by that metric is more than 10 times higher than Ford's, even though it has a similar ability to create free cash flow and their earnings growth outlooks that aren't that far apart.
What should Ford's valuation be?
It's not a simple question to answer, despite the comparisons above. Ford faces some risks, such as the possibility that EV sales might eat away at its existing gas vehicle sales. There is also no guarantee that Ford's EV business will be as successful as it hopes over the long term. But it seems difficult to make the argument that Ford's stock should be only 10% as valuable as Tesla's relative to earnings.
Perhaps Tesla's stock will need to come down to a lower valuation, or maybe Ford's valuation will continue rising toward Tesla's level. I think it's most likely a combination of both, which means that Ford's stock could continue to build on its 2021 momentum in 2022.
