Reading the equity market’s view of GM
Enterprise value is the market price of a company’s debt plus the equity market capitalization less cash. It’s the market price of the company. Dividing this by the company’s EBITDA gives you a standardized figure to compare companies. A higher value reflects the market’s expectation of higher future earnings.
In GM’s case, enterprise value declined due to expectations of increased costs with recalls and delays in achieving global profitability. The recent trading-down of GM to 3.2x EBITDA may indicate a buying opportunity. Toyota (TM) is trading just under 10x, well higher than Volkswagen (VOW), BMW Group (BMW), Ford (F), or GM. Overall, the index appears to be trading near 7x and you could invest in it by purchasing the exchange-traded fund CARZ.
Free cash flow yield is a company’s free cash flow per share compared to a company’s stock price per share. Free cash flow for this calculation is cash flow from operations less capital expenditures. Share price is the market price. Both numerator and denominator are divided by the number of shares outstanding. It connects the company’s free cash flow generation and the market price in terms of yield—how much free cash flow a company is generating compared to the price of one share of its stock.
As you can see from the chart above, GM’s free cash flow yield is increasing and is currently at 13.2 versus Toyota’s (TM) 13.8. This is from the denominator—the market value per share of GM declining from 40.95 on January 1, 2014, to 34.75 on May 2, 2014. This may also indicate a buying opportunity for GM. As we saw before, GM invested in R&D (research and development) for new products, has free cash flow to rationalize its manufacturing footprint, and has significant market share in the leading economies. Interestingly, VOW’s free cash flow yield declined in the past three months while the rest of the industry, GM, F, and TM, increased. Overall, you could buy the index by buying the exchange-traded fund CARZ.
Taking a look at market consensus can also provide a valuable insight into market pricing. Currently, GM is trading at less than 4x enterprise value to consensus-estimate EBITDA. Dropping F and GM would give you an 8x-to-10x forward-looking EBITDA. From this calculation, you could argue F is overvalued and GM is undervalued, while VOW, TM, and BMW are more fairly trading.