GM Gets Downgraded, Stock Rallies by 9%
Stocks usually go down after being downgraded by analysts, so GM stock gaining 9% after a downgrade seems very strange. These are not normal times though.
It’s been no secret that the automotive sector has fallen upon hard times, at least with the stocks in the sector. It is not enough for a company to just be making money when it comes to their stocks, and auto stocks such as GM have been making plenty, and are expected to continue to do so, but to see a stock grow the way we want to see it grow, to see it be competitive with other stocks that we could invest in instead, a stock needs to be able to keep up the pace growth wise.
A lot of people think that they have a good understanding of how stock prices go up, although it turns out that they only understand this at a superficial level. These folks would be in good company though as a lot of people who earn their living from trying to understand stock prices are stuck at the same level.
If we are going to do well at this game of investing, where we put our hard-earned money on the line to seek out the potential growth of stocks we may choose to play, the more we understand what propels these stocks, the better.
While it does pay to look at hot sectors to understand why these stocks grow faster than the market, we also need to look at underperforming sectors to understand why these sectors do so poorly relative to other sectors.
The auto sector certainly qualifies as a down one, and people may look at automakers such as General Motors and wonder how they could make a lot more money than other companies, even in the same sector, such as Tesla, but not get the amount of love from the market that they feel it deserves.
Tesla and GM are actually a great pairing to seek out the differences between a hot stock and a cold one, and everyone who scratched their head or even beat it against the wall when Tesla zoomed by GM in market capitalization need to pay close attention.
GM is by far the bigger of the two right now, so we might think that their stock should be worth more, a lot more, by virtue of this. If we think that though, we don’t understand anything about how stock prices work, because this is never about the present or the past, and all about the future.
If we look down the road with these two car companies, with GM being huge but with limited growth, versus Tesla which is small but has a lot more potential for growth, it’s not hard to envision a time where Tesla is a lot bigger than they are now and GM perhaps mostly treads water over this time.
Relative to where they are now, at this given point in the future, GM may still be very big and very strong but not a lot bigger or stronger than they are now. We start with what we feel the company is worth now, and add all this future value, which proportionately won’t be a lot, and we end up with a price.
The fact that GM is so big is actually a handicap, because this isn’t about how much money you make, it’s about how much more money you make. It’s easy to understand how much it would take for GM to double in size, and in fact they are big enough that nothing even close to this would even be possible. A company like Tesla, on the other hand, is much smaller and could double in size several times before GM has much of a chance to grow at all.
If we instead view this from the perspective of income, earnings overall or per share or any other conception that prioritizes current earnings, we’re going to end up quite confused. It’s how much earnings will grow that matters, relative to where they are now, and current earnings only represent a benchmark that we will compare future expectations with.
Stocks end up being priced by way of not current earnings but future earnings potential, and with our example, people expect Tesla to grow a lot and they are pricing this future growth in the stock price. Investors don’t expect GM to grow very much at all, even though they will, and the premium added to GM’s stock price is therefore much smaller.
These effects all play out in the market, and given that we can choose between stocks with a lot more growth potential than others, this is where we tend to put our money, in the ones that are expected to grow. We only need the belief about this growth to produce growth in a company’s stock price, as if we think that Tesla will be that big in the future, its stock will grow big now due to this causing it’s demand to rise so much.
When Even the Fundamentals Have a Stock Oversold, It Certainly Is
It is enough to say that a stock isn’t much in demand and therefore its stock won’t grow much or even go down, and the real and only reason for this lack of growth is that investors just aren’t expecting much. That’s certainly been the case with GM over the past few years, where it has held up pretty much until the coronavirus crash, but holding up isn’t what this game of investing is about, as we want stocks that go up, not just hang around a range.
GM had a couple of tough quarters recently, but looking at the earnings estimates over the next couple of years, at least the ones up until the recent shutdown of U.S. auto manufacturing, things looked pretty solid, but certainly does not represent the growth that it needs to become more competitive with stocks in general.
This is why this stock and stocks in the sector in general have not been worth our attention, at least if we are the sort that wants to do well with our investing, because this isn’t a stock that you are going to make enough money off of in normal times to ever want to be in it, when there are so many stocks that have a better outlook than this.
Up until recently, it would have been hard to imagine GM meriting anywhere near enough bullishness to want to own this stock, and we certainly would not expect such a situation to arise when the business is basically shut down and they are down to making medical devices, but these are strange times indeed as it turns out.
When you add in a decidedly bearish outlook such as Deutsche Bank analyst Emmanuel Rosner has just shared, with his seeing the sector falling upon even harder times going forward, we really wouldn’t tend to see this stock as being a buy, but with stocks, we have to look closer than just all this to decide.
Rosner downgraded GM from a buy to a hold on Tuesday, and with these analysts, holds are reserved for the real dogs. If you shouldn’t buy something, you shouldn’t hold it either, as buying involves holding and we’re talking about the same thing here.
We should never hold something we would not buy, and the reason why a lot of people become confused by this is that they see buying stock as being some kind of commitment, where if you buy it you would presumably be willing to be in situations where the outlook has turned, bad enough to not want to buy it, but you feel like you should hold it anyway for some reason. This is obviously not a strategy that will do anything but harm you.
Ironically, even if we take Rosner’s forecasts fully to heart, and use it to tweak the stock’s value down over where it was before this impasse, it still might be a buy here, a real buy and not just using this term to describe stocks we don’t see going down all that much.
How GM could have remained a buy as it lost over half of its value in a month and a half is not ever explained very well, even though we may think that we should do a lot better job to align our recommendations with the real world and not just try to lead investors off a cliff like this.
Once the shutdown ends, it’s not hard to imagine the aftermath affecting GM’s results, just from the hit that the economy will take. The reason why this stock and so many other stocks have so much potential here is that we have discounted these losses far beyond what they merit, for instance running down GM’s stock price to the point where it was only worth half what it was not that long ago, which is clearly overdoing things.
If we take where this stock was prior to their recent fall, and add in the losses from both the shutdown and this diminished outlook of Rosner’s, it’s just hard to justify it needing a haircut this big once this all passes.
We did not sell off GM from $34.65 in early February to $16.80 in mid-March, because they will lose production for a little while, we sold this stock so much because that’s what people were doing with pretty much any stock, apart from how poorly or how well a company may be doing.
We may wish to discount GM’s price a little in the face of this one analyst’s downgrade, but it’s hard to imagine how it could only be worth $25, Rosner’s new price target, because this additional slowdown that he sees just isn’t that influential. If, for instance, we were at $34 right now, and he sees this little slowdown as bringing the price of the stock down, it’s hard to imagine this new outlook putting it down by $9 a share, as the numbers just don’t add up.
As it turns out, the market disagreed with Rosner and put GM’s stock up a full 9% on the day of this downgrade. We’ve now moved up from this low of $18.04 to end last week, to $21.30 to close Tuesday. This is still below his target of $25, but we’ve moved a lot closer in just one day.
It is not that GM’s fortunes as we come out of this lockdown is all that special, and stocks that got taken down far more than they deserved are a dime a dozen these days, the norm actually, but if you ever wanted to own GM, and we’re not all that sure why anyone would, now would be the time to do it.
GM Should Have Gone from a Sell to a Buy, Given Its Current Price
Instead of changing his rating from a buy to a hold, this should have been a sell like every other stock should have been lately, but now some of these are becoming buys instead, and GM is looking like it is one of those. Even if it only goes to the $25 that Rosner sees it going to, that’s still a pretty nice gain over what will surely not take all that long, that’s still a 17% gain, not too shabby for just holding something for a few weeks.
We need to make sure that we are not greedy with this, and hold this stock past its corrective phase, as this is clearly not a stock we should want to be in normally due to its paltry growth and muted expectations. However, there is a gap to be filled here, the one that was created when we take how much this stock has fallen and how much of it was genuine and reasonable, and most of it was not.
We still need to pay close attention to the charts though, and GM already tried to break out on March 26, got as far as $22.56, and then dropped back all the way to $18 in short order. The mood of the market has improved a bit since then, and although we may want to wait until it takes out this resistance point, investors would not be too out of line to jump on now as long as they promise to hold it until this whole mess blows over.
Given that GM started this fall around $34, a new target of $30 seems reasonable enough, although we need to realize that we can’t predict these things well enough to rely on them in the heat of battle, and these forecasts are only valuable to provide us an idea of what the upside is, and the upside of $30 does tell us that there may be a fairly easy 30% or more up for grabs if we are up for this trade.
Those who had taken the advice to hold this are left to root to make some of their losses back, and this is why you don’t want to be in falling stocks, because there will be a time where things turn and instead of losing a lot on the way down and making some of it back, the road back can and should be an exercise in money making, not getting some of our losses back.
Even though the odds are now in GM’s favor due to it being slammed, this doesn’t mean that this trade doesn’t come with real risk, and if we get a market meltdown again, you can bet that GM will be taken down with it. Ideally, we would bail at the first sign of real trouble, if we were traders, and budding investors that feel confident enough that they can move in and out of this may want to give this a try.
However, the great majority of investors will prefer to do this in a single trade and just hold it until the dust settles and it has a chance to make up for the panic part of their drop, the part that was caused by the weight of the market itself and is not really representative of the stock or the company itself.
The risk in trying to time this is doing things such as buying into the last rally, around $22, seeing it drop to $18, and selling for a tidy loss just to see it rebound. This can’t be done effectively with such broad strokes, and good traders who tried such a thing would be out at the start of the failed move, not ride it all the way down like this. This is not a strategy that we can just get home from work and have a peek every night as it requires closer management than this to do it right, as a single day’s trading alone can cost us quite a bit and have us exiting well late if that’s what we’re looking to do, like in this example.
Just buying the stock and holding it for now takes the guesswork out of this, and since we can be pretty confident that this will end up between $25 and $30, we could pretty reasonably just hang on for that. Whatever happens to GM in the interim, when the plants are shut down and the economy is already in lockdown, things can’t get much worse for the company, and the market will at least mostly come back in good time.
The key to this and similar trades is the expectation that we won’t be locked down for all that much longer, but even if we take May off as well, things will have to come back sooner rather than later for us to even survive economically. GM will be back to making cars again, the economy will start to get back on its feet, and we will correct the excessive selling that this panic brought.
In spite of the talk we’re hearing about keeping the shutdown going for a year, or 18 months, or maybe forever, none of this is even possible, and while we’re told that we have no choice to keep things shut down for this long, the no choice part is on the economic side. As we are coming to realize more and more how far off the numbers that we’ve been given end up being, the health concerns will significantly decrease, and with the economic concerns continuing to mount, the economic rescue that we desperately need will win out and be put in place.
We will likely beat around the $18-$25 level for a while, but those who enter near the bottom like this at least won’t have the big yoke around their necks like those who held throughout this have, nor should they have the desire to hang on to this stock past its useful purpose, to look to capitalize on the reversal of the overselling we’ve done with this.
Analysts don’t really take technical factors into account as much as they should, and this is a pure technical play, so these folks aren’t going to be wise to these moves. They should be though, as all it would take is asking the question of whether our changed fundamental outlook is enough to put a stock down by 33% from where we started the year at $37 to this new target of $25, given that a stock’s price, even when understood fundamentally, involves timeframes that extend well beyond the vision and analysis of analysts like Rosner, who only look a year out generally.
Market tumbles can be a lot of fun if you manage to leave the big losses to others and then swoop in and buy stocks once people have beat them down so much, and you can even get in on this fun with an otherwise terrible stock like GM, if the time is right.
Editor, MarketReview.com
Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.
Contact Andrew: andrew@marketreview.com
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