Incentives have been rising on midsize sedans like Ford's Fusion. Will a price war clobber automakers' profits? Source: Ford Motor Company.
You've seen the headlines -- or at least the TV ads: Automakers have been boosting their incentives.
Incentives are the "cash back" and cheap-financing offers you hear about in advertising for new cars. They're funded by the automakers, not the dealers, and they're used to adjust a vehicle's pricing -- to offer a temporary discount, in other words.
They've been on the rise, or so we hear. For investors who own automaker stocks, that's worrisome: Incentives can boost sales, but at the expense of profits. When an automaker boosts its incentives to try to "juice" its sales, other automakers may boost their own incentives to try to keep pace. It's great for consumers when that happens, but it's less great for automakers: Sales may look strong, but big incentives erode profit margins.
And when we see incentives rising across the board, that's another kind of worry. It can mean that demand for new cars and trucks is falling, and that can be an indicator that the economy is slowing, that consumers and businesses are reducing their spending.
In other words, "cash back" discounts on new cars and trucks might seem like just an advertising gimmick, but they can turn out to be an important economic indicator.
Now, U.S. auto sales are still rising, but not nearly as quickly as we've seen in the recent past. Sales were up 13% in 2012 and 7.6% in 2013, but they're only up about 5% so far in 2014. However, despite smaller sales gains, automakers' profits haven't been falling. On the contrary: Ford (F 0.90%) earned $2.4 billion before taxes in North America last quarter (up 5% year over year), while Toyota (TM 0.24%) earned $1.4 billion (a 44% year-over-year gain), and General Motors (GM 0.40%) earned $1.4 billion despite spending $1 billion on its recalls (excluding the recall costs), a 20% year-over-year increase.
So sales gains have been shrinking, and incentives seem to be rising, but automakers' profits are up. What does that mean?
The Motley Fool's John Rosevear and Rex Moore recently dug into that question, looking at a new report from analysts at TrueCar.com. As they explain in this short video, while incentives are rising, the biggest increases are happening on one particular type of vehicle -- while overall transaction prices are rising as well.
