In 2004, motor vehicle sales were booming, as the economy was strong and customers continued to buy larger and larger vehicles. The stock prices of most car manufacturers (domestic and foreign alike) were at recent highs. Today is a different story, as the stock prices of GM (GM) and Ford (F) have plummeted from those highs, while Toyota (TM) and Honda (HMC) have held their own despite the tough environment. Assuming investors couldn't see the future (which would consist of high gas prices and a shift to fuel efficient vehicles), could investors have seen this coming back in 2004? After all, Ford and GM own some of the best consumer brands around...could they have represented value investments that just went wrong?
Not a chance. True value investors would have considered GM and Ford investments of only the most speculative variety. Why? Debt levels. Here's a look at the 2004 debt to equity ratios of the four companies discussed above:
Debt to equity levels much more than 1 make us a little bit uncomfortable. Debt to equity levels above 9 are astronomical!
As we've discussed before, low debt levels allow flexibility, add more certainty to the estimated equity value, and allow a company to weather downturns and emerge from them stronger than ever (as Toyota and Honda appear poised to do). Going forward, make sure you know the debt levels of any company you plan on buying for the long term.