By Auto makers seeking to enhance their stock returns should consider a fresh perspective on managing dividends.
Lackluster Stock Performances
Ford Motor and General Motors have both struggled with weak stock returns. Ford has only managed a modest 3% average annual return over the past decade, factoring in dividends. Meanwhile, GM has fared slightly better with a 4% return. This is in stark contrast to the impressive 12% total annual returns seen by investors in the S&P 500 index during the same period.
Root of the Issue
- Ford’s stagnant stock price of around $12 since February 2014 highlights its reliance on reinvested dividends for all returns. On the other hand, GM’s stock, currently trading at approximately $40, has witnessed a modest 10% increase during this time – with about 75% of its returns stemming from reinvested dividends. (Interestingly, it was valued below $27 as recently as November.)
Valuation Challenges
- Both auto giants face valuation challenges, with Ford trading at about 6.7 times estimated 2024 earnings and GM at around 4.5 times. In comparison, the S&P 500 trades near 24 times earnings – showcasing a stark contrast.
Underlying Strength
- Despite lackluster stock performance and valuations, both Ford and GM have demonstrated robust financial performance. Ford has generated roughly $100 billion in free cash flow over the past decade, while GM follows closely with approximately $75 billion.
Overcoming Valuation Hurdles
- Enhancing valuation multiples and boosting stock prices remains a daunting task. While innovations in new vehicles, particularly electric cars, could be a catalyst for growth, convincing investors of the industry’s potential as a growth sector remains challenging.
A Viable Solution
- A potential solution lies in optimizing the dividend payout framework. Ford appears to be making strides in this direction by committing to distributing 40% to 50% of its annual free cash flow through a combination of regular and special dividends. Notably, quarterly dividend payments have accounted for roughly 20% of free cash flow in the past two years, with special dividends contributing around 28%.
Differential Approach
- This strategic dividend approach may explain why Ford’s stock commands a higher price/earnings ratio compared to GM. Surprisingly, Ford offers an attractive yield of almost 5%, while GM lags behind at approximately 1.2%. A shift towards a more _GM_-like multiple for Ford could potentially yield an impressive 7% or higher. In comparison, the average dividend yield for an S&P 500 company stands around 2.5%.
General Motors’ Capital Allocation: Stock Repurchases vs. Dividends
General Motors, like many companies, returns capital to shareholders through stock repurchases and dividends. Over the past decade, GM has spent approximately $23 billion on buybacks and $16 billion on dividends.
Questioning the Effectiveness of Buybacks
Trivariate Research founder Adam Parker challenges the prevailing notion that buybacks are a wise use of capital. Despite the common belief that buybacks are similar to tax-efficient dividends, Parker argues that, in aggregate, buybacks have not proven to be beneficial.
Looking at GM’s performance over the past decade, it’s apparent that the stock price remained stagnant despite a reduction in shares outstanding from 1.6 billion to less than 1.2 billion. Parker suggests that deploying capital elsewhere might have been a more prudent strategy compared to buybacks.
European Investors’ Perspective
In Europe, companies like Mercedes-Benz Group, BMW, Volkswagen, and Stellantis have provided investors with an average return of about 9% annually over the past decade, with dividends contributing significantly to this return. This stands in contrast to GM’s focus on share repurchases.
Advocating for a Different Approach
Freedom Capital Markets analyst Mike Ward proposes a novel strategy for Ford and GM: setting aside a portion of cash flow into a dedicated account for regular dividends. By building up this fund, Ward believes it can offer more stability and support for the stock valuation in times of market volatility.
While Ford and GM have not responded to Ward’s suggestion, a shift towards prioritizing dividends could potentially benefit both companies in the long term.
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