Back in the 1910s, Henry Ford showered capital stockholders of The Ford Motor Company with regular dividends and larger special dividends as the booming growth of the Detroit locomotive manufacturer was gushing out profits well above what could be reinvested into the company and set aside for a rainy day. Whether or not they realize it, the current Board of Directors are following in the capital allocation footsteps of Ford himself by yesterday declaring a $0.15 quarterly dividend in addition to a $0.25 special dividend that will be paid on March 1st.
This has gotten a lot of income investors excited. And I understand why. At $12.85 per share, the $0.60 annual dividend represents a 4.66% dividend yield. The $0.40 dividend on March 1st (which includes the special dividend payout) represents an immediate cash return of $3.11 for every $100 of Ford stock that you own today. The investors that own Ford stock right now stand to collect 6.61% in income this year from a company that is making $6.2 billion in annual profit.
If you’re holding Ford stock for the short term, I have no thoughts on that. But if you are considering buying Ford stock for the long haul, now is a good time for me to give a public service reminder about the peak earnings trap and the terrible long-term characteristics of the automotive industry in general.
First, the data points: Over the past twenty-five years, Ford stock has compounded at 4.75% annually. And keep in mind that Ford has outperformed its peers General Motors and Chrysler–these are American industry leader returns. If you compare Ford stock from 1991 through the bottom of the economic cycle in 2009, your returns would have been -2.59% annualized so that a $10,000 investment in Ford stock back in 1991 would have become $613 in the summer of 2009.
Why is it that Ford, as a member of the automotive industry, delivers such poor long-term returns to shareholders? Because the industry profits are like the Matthew Ryan song “I Can’t Steal You”–you watch the profits build up, and then they are all gone in an instant. This is what economists call the peak earnings trap–when the business is booming, profits are rising rapidly, and special dividends are showing up, the stock’s attractiveness is most misleading because a turn in the economic cycle will greatly affect the firm’s fortunes (and the opposite is true–the plummeting profits, dividend cuts, and general malaise are often a sign of buy-low value.)
Keep this in mind about Ford: profits in the late 1990s climbed from $1.28 per share to a high of $5.86 in 1999. Back then, the growing profits may have seemed like Ford was a worthy investment. Then, profits took a hit to $3.22 in 2000 and Ford lost a whopping -$3.02 in 2001. Just as profits started to rebuild at $2.13 per share in 2004, another wave hit: -$1.50 in 2006, -$0.19 in 2007, -$3.13 in 2008, and $0.00 in earnings in 2009.
The dividend, after hitting a high of $1.88 in 1999, got cut to $0.40 for 2002 through 2005, before being eliminated entirely in the years 2007 through 2011. Here we go again, with the $0.20 dividend in 2011 rising to $0.60 annualized now (or $0.85 counting the special dividend). It’s still well below where the earnings and dividends were in 1999, and this illustrates how automotive companies do not have the high certainty of passing through each business cycle in a stronger position than the last.
Most analysts forecast a strong five years ahead for Ford–rising dividend payouts, higher earnings, and a corresponding rising stock price (the high end estimates are calling for Ford to be a $35 stock!). It’s six years into an expanding economy, and gas prices are incredibly low. These inputs have made people bullish on Ford. The F-150 has increased in price by $2,800 on average. This current environment cannot be extrapolated indefinitely into the future–oil will rise, chilling F-150 demand, and an eventual recession tends to hit Ford hard (with profit declines coming in the 50% to 75% and matching price declines to boot.)
Really, it’s a question of whether the successful years are enough to compensate for the down years. The strength of years like 1999-2000, 2004-2005, and 2013-2015 do not offer high enough profits to justify experiencing 2001-2002 and 2006-2009. The strength of the upside is eclipsed by the declines on the downside, and that is why Ford has a struggling twenty-five year record.
Peter Lynch said that the problem with brand-focused investing is that people think, “Oh, I’ve heard of that company, and it’s been around forever, so it must be a good investment.” That works in certain industries–if you buy and hold Nestle, Coca-Cola, PepsiCo, or Hershey on that theory, you will do well absent substantial overpaying. But it does not extend to airlines and automotives, where the downside is so great that it eclipses the profits earned during the strong parts of their business cycles.
You also want to avoid diworsification–there is no need to adopt a Noah’s Ark approach to investing as the benefits of airlines and automotives do not offset the structural problems these companies contain (though if you must enter the industry, focus instead on companies that repair cars or planes as the profits are much higher and less cyclical because people hang on to old things longer during recessions and thus increase the need for repairs.) Ford is exciting investors now with special dividends and an attractive current dividend yield, but if history and the nature of the industry is any guide, the current investor mood of exuberance for the company will prove ephemeral.