The price-to-earnings ratio (P/E) is one of the most popular metrics of stock price. It is often used as a crude indicator of market sentiment as a simple, easily understandable ratio.
When the prices are significantly above the historical averages of P/E 12-15, stocks in single digits mandate further examination. Is there more than meets the eye? Or is the market's lack of favor a correct opinion?
Today we examine one of those stocks in General Motors Company (NYSE:GM). The ratio of 8.8x might make it look like a strong buy right now compared to the market in the United States, where around half of the companies have P/E ratios above 19x, and even P/E's above 39x is quite common.
Recent times have been advantageous for General Motors as its earnings have been rising faster than most other companies. It might be that many expect the strong earnings performance to degrade substantially, which has repressed the P/E. If you like the company, you'd be hoping this isn't the case so that you could potentially pick up some stock while it's out of favor.
The company is rallying to join the electric vehicle (EV) party, working on as many as 30 new EV models are coming out within the next 3 years. Yet, swiftness is the enemy of precision – just days ago, they announced a recall of 69,000 Chevrolet Bolt vehicles due to fire risk concerns. This is the second such occurrence since the problem has not been fixed after an initial recall in November. Unless GM can identify defective batteries, they will have to suffer the cost of complete replacement. Earlier this year, Hyundai Motor Co faced a similar problem that ended up as a US$900m loss.
Additionally, in the wake of the global shortage of semiconductor chips, GM is halting the production of full-size pickup trucks for at least one week.
Want the full picture of analyst estimates for the company? Then our free report on General Motors will help you uncover what's on the horizon.
What Are Growth Metrics Telling Us About The Low P/E?
To justify its P/E ratio, General Motors would need to produce anemic growth that's substantially trailing the market.
If we review the last year of earnings growth, the company posted a terrific increase of 89%. Although, this is skewed with the 2020 market crash, as its longer-term performance hasn't been as strong, with three-year EPS growth being relatively non-existent.
Turning to the outlook, the next three years should generate growth of 3.0% per annum as estimated by the analysts watching the company. The company is positioned for weaker earnings results, with the market predicted to deliver 14% growth per year.
We can see why General Motors is trading at a P/E lower than the market. It seems most investors are expecting to see limited future growth and are only willing to pay a reduced amount for the stock.
The Bottom Line On General Motors' P/E
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that General Motors maintains its low P/E on the weakness of its forecast growth lower than the wider market. Right now, shareholders accept the low P/E as they concede future earnings probably won't provide any pleasant surprises. Unless these conditions improve, they will continue to form a barrier for the share price around these levels. While the good catalysts might include the success of GM subsidiaries like autonomous vehicle startup Cruise, it remains to be seen.
You should always think about risks. Case in point, we've spotted 1 warning sign for General Motors you should be aware of.
You might be able to find a better investment than General Motors. If you want a selection of possible candidates, check out this free list of interesting companies that trade on a P/E below 20x (but have proven they can grow earnings).
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.