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3 Things You Must Know About General Motors' Downgrade

By Rich Smith - Feb 29, 2016 at 10:00AM

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A former bull on the stock pulls in its horns.

With shares down 14% since the start of the year, General Motors (GM 1.35%) is not having a happy 2016 -- and it could get worse. This is according to analysts from Argus Research, which ranks in the top 10% of investors we track here at Motley Fool CAPS.

The news
Earlier this morning, Argus released a report downgrading shares of General Motors from buy to hold. This seems strange, given that Argus stripped GM of its buy rating just weeks after the company reported a banner fiscal year 2015, in which revenue from abroad declined somewhat thanks to foreign exchange headwinds, but General Motors profit surged 65%. So what is it exactly that Argus doesn't like about the new and improved -- and profitable -- GM?

Here are three things you need to know about the downgrade.

Thing 1: Argus just called the top
Argus thinks that 2015 was just about the top of the automotive cycle in the U.S., and 2016 could be the year things finally crest and begin to roll downhill. According to data from S&P Global Market Intelligence, GM's unbroken string of rising sales led to superb profits in each of the past five years. And GM's U.S. profits surged again in Q4 of 2015.

But according to Argus, GM's sales of U.S. light vehicles will eke out barely 1% worth of sales growth in all 2016.

When analysts talk about "light vehicles" in the context of General Motors -- this is what they really mean. Image source: General Motors.

Thing 2: Remember Thing 1? That was the good news
Argus sees things rolling downhill even faster outside of the U.S. According to the analyst, investors should be looking for even slower growth in international sales. Worse, sales could actually "decline" in some "emerging markets."

Thing 3: ...and that's OK
But make sure you're sitting down and buckled up before you read this next line: Despite all the bad news that Argus tells us to expect in 2016 and beyond, and despite the fact that this bad news has Argus downgrading GM stock, the analyst nonetheless tells us that profits are still growing at GM.

And not just growing, but growing faster than Argus used to think they would.

As revealed in its downgrade, Argus says GM profits will expand to $5.50 per share in 2016, a near-10% increase over the $5.02 per share in 2015. And then, in 2017 (remember that 2017 is the year after GM supposedly peaks), Argus says profits could jump again to $5.70 per share.

One more thing
If that sounds to you like a strange reason to downgrade a stock, well, it sounds a little strange to me as well. The more so when you realize that just days before Argus released its downgrade on GM, J.D. Power & Co. came out with its 2016 Edition Vehicle Dependability Study -- that showed GM is now top o' the heap among U.S. carmakers for quality.

As fellow Fool and automotive specialist John Rosevear described over the weekend, GM brands captured half of the top six slots on J.D. Power's recent report, with each of General Motors' Buick, Chevrolet, and GMC brands winning top slots.

True, GM brands gave up the No. 1 prize to Toyota's Lexus (but then, that's usually the case). Meanwhile, GM beat archrival Ford (F 1.71%) with a stick. Ford's Lincoln brand barely made it into the top 10 on J.D. Power's list. The "Ford" brand proper scored next to last, beating only Dodge in the dependability of its cars, three years after manufacture.

What it means to investors
Now, I don't mean to discount the impact of a strong U.S. dollar, or how it can make U.S. cars more expensive relative to foreign offerings, and hurt international sales. But price isn't the be-all and end-all in consumers' shopping decisions. Quality plays a role as well -- and right now, General Motors is churning out quality in spades.

As John explains, it's a "truism in the auto business ... that if an automaker builds great products and keeps costs under control, sales and profits will follow. In part, that's because great products don't need big margin-eroding discounts to sell well."

We saw that rule play out in GM's bumper crop of profits last year. And according to Argus, we'll see it in continued rising profits in 2016 and 2017, as well. At a share price of less than 5 times the profits it produces, GM stock is worth a good hard look.

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