A few weeks ago, at Ford Motor Corporation’s annual investor day shindig, the company announced that profitability for the company this year would be negatively affected by three separate issues:

  1. Greater than anticipated losses in South America
  2. Greater than anticipated losses in Europe
  3. Greater than anticipated costs related to recall actions.
Sell-side (e.g., Morgan Stanley, Goldman Sachs, and other brokerages who serve mostly institutional clients) research teams downgraded the stock and cut price targets as the stock tumbled.
Since Ford is a holding in the IOI Model Portfolio, I have analyzed Ford’s statements and the arguments put forward by the sell-side analysts, but still do not believe there is enough information available to assess which of the valuation scenarios outlined in our April 2014 Tear Sheet and investigated in our Valuation Notes.
Sell-Side Commentary
Most sell-side researchers set “target prices” for stocks by forecasting near-term earnings-per-share (EPS) and applying a multiple to that forecast EPS.[1]
The EPS can be changeable due to various accounting issues and / or one-off events. Also, the essence of a multiple is its role as a shortcut method to describe the likely future growth of a given operating metric; however, those applied by sell-side firms lose this economic meaning and obfuscate the relationship with growth that they should be expressing.
For instance, after the company presentation, Credit Suisse’s analyst, Dan Galves, cut his price target for Ford from $18.00 to $15.50 on the basis of his 2014 EPS estimate falling from $1.32 to $1.11. Presumably, he was applying an EPS multiple of about 13.6 times EPS for the firm, and making a simple calculation based on his revised estimate ($1.32 * 13.6 = $18; $1.11 * 13.6 = $15.50).
Of course, this analysis begs the question as to whether an EPS multiple of 13.6 times represents a sensible growth rate for the firm’s profits. In fact, applying a discount rate of 10% to Ford’s future earnings implies that Fords earnings per share will continue to fall in perpetuity. (I discuss discount rates in The Framework Investing and give an argument why 10% is a sensible rate to use for large cap firms in most circumstances).

IOI Analysis
Our original analysis of Ford had worst-case revenue growth averaging -1% per year over the next five years and best-case revenue growth averaging 3% per year over this time period. 
In the first half of 2014, Ford’s has generated a total of $73,287 in revenues, representing a year-over-year change from the first half of 2013 of -0.4%.
While -0.4% is relatively closer to -1% than to 3%, keep in mind that only one quarter’s worth of data has been recorded since our original analysis was done. As such, it seems hasty on the basis of only this evidence to say that one or the other of our scenarios is more likely to occur.
To analyze profits at IOI, we use a figure termed “Owners’ Cash Profits (OCP)” that is based on Cash Flow from Operations and an estimate of money required to be spent on maintenance capital expenditures. (For a detailed example of a valuation using this metric, please see the online appendices to The Framework Investing).
Unfortunately, Ford does not split out all the necessary lines to make this calculation in its quarterly statements, and it is impossible to calculate a precise value for OCP without the full statements. Eyeballing the statements suggests OCP margins of around 3% so far in 2014, which is, in fact just about halfway between our original valuation scenarios of 1% OCP margin (worst-case) and 7% OCP margin (best-case).
Again, our estimate of the actual OCP margin value gives little reason to believe that one or the other of our valuation scenarios is correct. So little time has passed, that we are content to continue monitoring the company before making any tweaks to our valuation estimates.
IOI Investment Strategy
The position in Ford is a small, unlevered one, and considering the beating the stock has taken over the past few weeks (exacerbated by a general fall in the markets), I’m happy for this allocation. The stock has fallen in price since we purchased it, but it is still not cheap enough ($10 range) for me to want to increase exposure to the name, so I am content staying put for right now.

[1] EPS is not the only operating metric used, but the process is basically the same for other ones: forecast a value for some target metric and apply a multiple to that metric to derive a target price.
[2] This information was taken from an article on 24/7 Wall St.