Higher-than-expected warranty costs led Ford Motor Company (NYSE: F) to miss bottom-line estimates in its second quarter. Consequently, shares tanked following the news.
This continues a streak of weak returns for the Detroit carmaker. To say that this auto stock has disappointed shareholders would be putting it lightly. In the past 10 years, shares have produced a total return of just 19%. At the same time, an investment in the S&P 500 would’ve netted 249%.
So should investors buy, sell, or hold Ford stock right now?
To be clear, I’m bearish on Ford (more on this below). However, knowing why investors might want to still buy and hold this stock is important to gain a comprehensive understanding of the situation.
One reason why shares might be compelling is because of the high dividend yield of 5.7%. This is much better than the average 1.3% yield of the S&P 500. And it’s something income-seeking investors can certainly appreciate.
Another reason to want to buy and hold the stock is the valuation. Shares trade at a price-to-earnings ratio of 11, which is less than half that of the broader index of 500 large and profitable companies. But as I’ll discuss, this low valuation is totally justified, given the unfavorable qualities this business possesses.
One reason I feel so strongly that investors should avoid adding this stock to their portfolios, or why it should be sold if you’re an existing shareholder, is because this isn’t a high-quality business. In other words, it’s difficult to argue that Ford possesses an economic moat.
One clear way to show why this is the case is by looking at return on invested capital (ROIC). Ford’s ROIC has averaged just 2.7% in the past decade. There’s almost a virtual certainty that this is lower than the company’s weighted average cost of capital. This shows that Ford is likely destroying shareholder value, which is not what investors want to see.
Leading companies in other industries, like Visa in payments and Apple in technology, have much higher ROIC metrics. Of course, part of the reason Ford’s ROIC is so low has to do with the nature of the auto industry. But you get the idea of just how unattractive the business is from this perspective. It has no durable competitive advantages that allow it to earn a high ROIC.
Let’s get back to the auto industry. Generally, this area of the economy requires massive, ongoing capital expenditures simply to maintain a company’s current competitive position. Ford must spend heavily on research and development and manufacturing, for example.
Then there’s the high labor costs. Ford has to deal with costly contract renegotiations every few years with its unionized workforce. If the business doesn’t bend to the demands asked of it, workers go on strike, which shuts down factories temporarily. No automaker wants that.
The industry is also known for registering anemic growth. In 2010, 66.7 million passenger vehicles were sold worldwide. Even with the rise of electric vehicles, that figure totaled 74.8 million in 2022. The 12% increase over that 12-year stretch isn’t anything to write home about. And it doesn’t provide Ford with a favorable backdrop to post strong revenue growth over an extended period of time.
There is no shortage of reasons to sell this stock. Sure, the low valuation and high dividend yield can be compelling for some investors. But Ford’s track record is disappointing. If you remain bullish on this business, though, I think it’s best to prepare for returns that seriously lag the overall market.
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Apple and Visa. The Motley Fool has a disclosure policy.
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