When it comes to betting on the automotive sector, nothing’s as wild as the dealer. Auto manufacturers may have their stops and starts, but shares of major car dealer chains are on a tear – prices of the right stocks have risen as much as 193% since last July.
Top names in the sector include: Lithia Motors (NYSE:LAD), AutoNation (NYSE:AN), CarMax (NYSE:KMX), Group 1 Automotive (NYSE:GPI), Sonic Automotive (NYSE:SAH), Penske Automotive Group (NYSE:PAG), and Asbury Automotive Group (NYSE:ABG).
One way to sift through these stocks is to use price-to-earnings-to-growth (PEG) ratios, which measure valuation in the context of expected growth, may be even better. A PEG ratio of less than 1 points to an undervalued stock, while a PEG ratio of more than 1 indicates a stock price higher than the company’s earnings growth.
Asbury has the lowest PEG ratio at 0.4;. Lithia, Group 1, and Sonic all have PEG ratios of 0.6. AutoNation’s PEG ratio is 1.0. CarMax is higher than its peers at 1.32. That’s probably a long way of saying that there’s still good upside potential in this group of stocks.
Of course, the sluggish first-quarter economic data released on Thursday may dampen investors’ spirits. The U.S. economy posted an anemic 1.8% growth rate in the first three months of 2011, pressured by higher gas and food prices. A further buzz-kill: new unemployment claims rose by 25,000 last week. Economists had expected them to drop by 12,000.
Still, one quarter with stormier than expected stats does not, on it’s own, sink retail auto sales. In fact, here are five reasons shares in these companies are still a pretty good bet.
1. Fewer Cars = Higher Margins. The triple disaster in Japan will reduce short-term inventories on some of the most popular vehicle models from Toyota (NYSE:TM), Honda (NYSE:HMC) andNissan. The disaster already has taken a heavy toll on production in Japan — Toyota alone lost 62% of its vehicle output in March.
2. Higher Gas Prices. I know, that logic seems crazy. And in truth, higher gas prices are never a good thing for the economy. But Paul Taylor, chief economist for the National Automobile Dealers Association recently said that higher gas prices will fuel consumer demand for small cars and hybrids. The rule holds true both for new and used cars. Because there were fewer new car purchases or leases during the 2007-2009 recession years, there are fewer used vehicles available now. That means higher prices for buyers and better margins for dealers.
3. Pent-up Demand. The recession’s sharp pullback in consumer confidence – and spending – is rebounding. During those recession years, consumers were content to fix up the old jalopy rather than drop a lot of cash on a new model. But the economy is improving (albeit with stops and starts). And consumer spending did increase by 2.7% in the first quarter, “well above the consensus estimate of a 2% gain,” Goldman Sachs noted on Thursday.
4. Credit Availability. Consumers are finding it a little easier to get credit and the auto lending market is growing more competitive. That makes it far easier for consumers to “sign and drive” their dream cars off the dealer lot.
5. Technology-assisted Sales. After the huge shakeout in the auto retail space, dealers have made great strides toward using technology to more cost effectively manage inventory and market vehicles. Giving consumers the power to access vehicle information online and essentially comparison shop through independent sites like AutoTrader.com is improving dealers’ business models and positioning them for strong future growth.
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