Test driving carz

August 24, 2016 01:00 PM

Last month we talked about how there were a number of stocks and cyclical sectors still offering a compelling combination of reasonably priced growth and nice dividend yields. Investors who are wary of the retail industry might find themselves tempted by the fact that industrial titans like Ford (F), General Motors (GM) and Toyota (TM) are all trading at low single digit price-earnings ratios (P/E) and with hefty dividend yields. You might want to pump the brakes before buying an auto exchange-traded funds (ETF).  

First let’s play investor psychologist; when you hear “automotive industry” what leaps into your mind?  Is it about Uber, Tesla (TSLA) or the rise of self-driving cars?  What about the fact that the American auto industry set a record for vehicle sales in 2015 and then sold even more cars in the first five months of 2016 than the previous year? Like the dire predictions leading up to the Affordable Care Act that kept a lid on healthcare stocks, the news that American vehicle sales had reached a new peak was seemingly buried beneath a constant stream of “sexier” articles that captured the attention of investors (like Tesla’s attempt to enter the mass consumer market) and helped suppress returns for auto investors.

So how cheap are these big names? (Thanks to pessimism about their long-term prospects, Ford and GM are trading at low P/E multiples, 5.72x and 4.33x respectively, compared to 19x for the broader Consumer Discretionary Select Sector SPDR (XLY) while their price-to-sales ratios are both below 0.4. Seems cheap,  but if you want to understand just how cheap, consider the headline grabber that Tesla had a market cap of close to $30 billion in late June compared to $42 billion for GM despite delivering only 50,508 cars in 2015 compared to 9.8 million for GM.

All the doom and gloom might be why the sector is almost completely unrepresented by any fund with the First Trust Nasdaq Global Auto ETF (CARZ) being the sole ETF dedicated to the sector and with only $26 million in assets (see “Overlooked”). Putting that into perspective, there’s the same number of ETFs devoted to the companies that sold $570 billion worth of products to U.S. consumers last year as there are to the video game and drone industries. For some, that might make a convincing argument that the sector is overlooked but prudent investors might want to take a closer look under the hood before taking CARZ off the lot.

One thing investors have learned from the Tesla saga is that it’s not easy starting a car company from scratch, which makes the sector heavily concentrated and provides another reason why there’s only one ETF devoted to the space with CARZ having just 33 names in its portfolio. The fund is market cap weighted so Ford and GM are two of the largest positions, but investors looking for pure U.S. exposure are in for a disappointment, as the fund has heavy foreign exposure. U.S. stocks make up a mere 25% of the fund with Japanese manufacturers like Toyota and Honda representing 36% of the assets and European names making up another 21%. What that gets you is a much higher correlation to changes in the MSCI EAFE index than the S&P 500 demonstrated by a three-year annualized return of -2.89% through the end of June compared to 11.6% for the S&P 500.

Value hungry investors might find CARZ to be an overlooked bargain, but remember that it doesn’t come with a warranty.

About the Author

Matt Litchfield is content editor for ETF Global (ETFG.com) and is responsible for all posts and new product updates on ETFG.com. @ETF_Global