Why is the automotive sector a good choice for value investing? The automotive sector is a good choice for value investing because it is a cyclical industry that becomes cheap during recessions and very expensive during market peaks. The automotive sector is leveraged to the business cycle and consumer confidence. Automobile sales grow only when consumers are feeling confident enough about the economy and their job prospects to justify a major purchase. Automobile sales are th
Why is the automotive sector a good choice for value investing?
The automotive sector is a good choice for value investing because it is a cyclical industry that becomes cheap during recessions and very expensive during market peaks. The automotive sector is leveraged to the business cycle and consumer confidence. Automobile sales grow only when consumers are feeling confident enough about the economy and their job prospects to justify a major purchase.

Automobile sales are the primary factor in determining the health of the automotive sector. Coming out of recessions, this sector is one of the best performers due to a number of factors. With high costs and debt loads, automotive stocks become quite depressed during recessions as there is heightened bankruptcy risk. Further during this market environment, investors have a fearful mentality. This translates into opportunities for value investors, as selling is emotionally driven rather than based on fundamentals or reason. In this environment, a wide divergence forms between value and price.

During recessions, consumer confidence and disposable incomes are battered, leading to declining revenues for automakers. Once the economy begins to recover, there is considerable pent-up demand as consumers and businesses have put off vehicle purchases during the recession. Further, interest rates have been cut by central banks, which leads to lower financing costs, creating more demand.

For these reasons, the automotive stocks that are able to survive the recession by cutting costs, refinancing debt and continually innovating are in an excellent position when the economy does begin to heal. Value investors outperform when they can correctly identify the companies that survive these conditions. Certain companies go bankrupt because they overextend themselves during the prior expansion.

As economic growth continues and consumer confidence strengthens, automotive companies begin earning strong profits and are rewarded for increasing production. Many companies take on debt to expand or invest more into research and development. When the economy slows and revenue begins to drop, this aggression can become a liability as prices are cut. Interest rates tend to be higher at this point, making debt payments more challenging.

These extreme swings in the boom and bust cycle are what make automotive stocks such a good choice for value investors. The major factor accounting for the extreme swings is debt. Running any type of automotive company requires loads of debt whether it is an automobile manufacturer, auto parts supplier, auto dealer or auto parts store.

These are massive, complex operations. The debt loads create leverage and make these companies vulnerable to small shifts in economic growth or interest rates. When rates are high and growth slows, automotive stocks are the biggest losers. When rates are low and growth picks up, this sector has the biggest winners. Value investors also know that in the future people will buy automobiles, and growth will follow the recession. Thus, the value investor is focused on finding the companies with the largest margins of safety to endure the recession.
 
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