* Although these charges are reflected in eamings, they do not show in cash flow. Granted the depreciation must be made up eventually, it gives the company breathing space if it needs it to meet payments in financially difficult years, t Another way of avoiding this problem is to average eamings over a period of time- say five years-for a cyclical company. Doing this for Ford for the five years ending 1992, where it reported a $2.40 a share loss, would have resulted in average eamings of $2.62 a share. Using the same price of 13, the P/E ratio now is under 5, which still makes the stock appear very cheap.

such as depreciation in bad years.* If you tried to buy nonnally low-P/E cyclical stocks in a recession, when earnings of these companies tumble, the P/Es can get very high-if not infinite.

Ford, for example, in a bad period for autos, made only 92 cents a share in 1990, down from $4.57 a share the previous year. Because of the large drop in eamings, the P/E rose to 14 from 5 the year before. By price-to-cash flow, however, it was still dirt cheap, trading at a little more than 2 times cash flow at its low of $13 that year. In 1991 eamings crashed; Ford reported a $2.40 a share loss. The P/E was now infinite, so the low-P/E buyer would not touch the stock. Still, it traded at a modest 3.6 times its reported cash flow of $3.62 a share that year. The stock looked undervalued.

Once again the financial pages, and sometimes the front pages, blared out the tale of how the American auto companies would be left in the dust by the Japanese and Europeans, through poor management, insurmountable inefficiency, and lack of vision. Forgotten, apparently, was that Ford was one of the lowest-cost producers in Europe and that auto cycles were almost as old as the automobile itself. Moreover, Ford also had a low price-to-book value, trading at about 60% of its book value in 1991, about one-fifth the markets.

Finally, the company, despite cutting the dividend rate, ranked very high by the price-to-dividend measure, our useful secondary strategy, yielding an average of 7.6% in 1990 and 6.4% in 1991. The dividend is an important indicator of how management sees the future. Although Fords board of directors cut the dividend from $1.50 a share in 1989 to 80 cents a share in 1992, that they paid any dividend at all indicated their confidence that the company was not in financial difficulty, despite the sometimes shrill comments of analysts and the press. Only in their minds was the company going down for the third time.

I recommended Ford in my Forbes column of January 6, 1992.

Cyclical stocks-airlines, autos, forest products, et al.-are now as cheap relative to the market as at any time in the postwar period. As a

100,000

80,000

60,000

40,000

20,000

12/90

12/91

12/92

12/93

12/94

12/95

Source: Prepared from FactSet data

group these stocks are actually selling lower than after the October 1987 crash. . . .

All of which may have created an extraordinary buying opportunity. As the economy recovers, these companies should get a lot of bounce from the cost-cutting in recent years as well as from comparisons with quarters in 1991 that showed large restructuring charges. . . .

GM and Ford have slumped to 12-month lows in recent weeks. Major cost-cutting and a tight rein on inventories should result in a substantial swing in the bottom line when consumers come back to the showrooms. Ford (12M) is currently hurting not only from weak domestic sales but also from the poor results of its normally highly profitable European and financial groups. The company is Hkely to show modest profits this year, with substantial improvement in 1993. Ford has also recently bolstered its balance sheet with a large $2.3 billion preferred issue.

Figure 8-7

Ford Motor Co.

Time for a Miss

4. Westinghouse

Westinghouse, a blue chip for generations, was a cheap stock in the fourth quarter of 1990 at $25, down from a high of $38, because of the sha market sell-off accompanying the Gulf Crisis. After GE, it was the nations second largest electrical equipment manufacturer. Like GE, Westinghouse had a rapidly growing financial group, and in addition, a highly profitable broadcasting sector. Moreover, since the mid-seventies, the company had made amazing progress, with eamings increases in virtually every year. The stock rewarded its shareholders by ten-folding from its low in mid-1974, and management said more of the same type of growth was a-coming.

It also scored high by every contrarian strategy. At the $25 price, its P/E was 7, well under the 13 of the market. It traded at 4.5 times its cash flow and at 1.6 times its book value. All very cheap, even in a depressed stock environment, and for kickers it yielded a well-above-market 5.2%.

It also ranked high by many of the financial indicators. It was rock-solid financially (indicator 1), with debt less than 20% of the capital stmcture. Also impressive were indicators 2, 3, and 5-a good number of favorable financial and operating ratios, an above-average rate-of-eamings growth, and above-average yield as well as an increasing dividend. Here was the ideal contrarian stock-or so it seemed.

As it tumed out, there was only one minor hitch-the companys financial division.

Being heavily involved in financial stocks in 1990, the year of the major financial crisis, I was naturally concemed about Westinghouses rapidly growing financial division, which had a major stake in real estate. We analyzed it carefully, discussing it with management virtually profit center by profit center. Not to worry, they told us; they didnt do anything foolish like those real estate developers, banks, and other financial institutions. Everything was well in hand.

And so it seemed, until they reported their first billion-plus write-off in 1991.

1 was using what I believed to be a conservative eamings forecast for Ford, but the estimate proved far too high. Ford reported a 73-cent-a-share loss for the year. But it didnt matter. The stock was so cheap, it bounced up to $22 by early 1993, appreciating more than 75% from the point I recommended it and kept climbing. In October 1997 it traded over $50.