Unlike the slimy voices that you often hear on Wall Street, I’m not going to invoke a game of word salad to present auto dealership Sonic Automotive (NYSE:SAH) as an excellent idea. Clearly, with SAH stock down 29% on a year-to-date basis, you would have been better off buying shares of the benchmark SPDR S&P 500 ETF Trust (NYSEARCA:SPY). However, at this moment, SAH stock is significantly undervalued.
Let’s get the bad news out of the way first. A brief glance of the charts will show you that not many individual securities have performed well so far this year. Obviously, the prime negative catalyst for the malaise is inflation. Since January 2020, the purchasing power of the dollar declined by nearly 12%. For context, between the beginning of 2013 and the end of 2019, the greenback shed 10.4% of purchasing power.
What this dynamic translates to is a horrific realization that the months and possibly years ahead may be economically traumatic for households. Core readings for consumer sentiment are down substantially. Even the concept of revenge travel isn’t holding water, with analysts becoming very bearish on cruise liners in particular. Therefore, the narrative for SAH stock — which essentially underlines most households’ second-biggest purchase — is admittedly troubled.
Still, here’s why risk-tolerant contrarians might not want to give up on Sonic just yet.
SAH Stock Is Fundamentally Undervalued
Interestingly, when you drill into Sonic’s financial picture, you’re mostly met with very positive core fundamental metrics. The most glaring issue with the company is its Sloan ratio of nearly 27%, which may point to poor quality of earnings. However, the other signs imply an optimistic profile of SAH stock.
For instance, the company’s profitability metrics are very strong. Granted, you would expect that given the unique nuances of the coronavirus pandemic. However, key gauges are well above industry norms. Take a look at Sonic’s return on equity as an example. At 39.3%, it ranks well above the sector median’s 6.1% reading.
Further, according to Gurufocus.com’s assessment, SAH stock is “significantly undervalued.” Utilizing a basket of valuation metrics, SAH may present an upside opportunity for those willing to take a shot now. To drill into the specifics, you can reference its forward price-to-earnings ratio of 3.4 times, which is well below the industry median of 9.6 times forward P/E.
Another popular tool is the price-to-earnings-growth (PEG) ratio, which helps investors value an equity unit by accounting for the underlying firm’s market price, earnings performance and future prospects for growth. For SAH stock, the PEG stands at 0.72, again noticeably below the sector median reading of 1.8.
Still, there’s an argument to be made that assessing valuation can sometimes lead to cute math tricks that don’t correspond with reality. And reality right now seemingly dictates that consumers are in no mood to buy cars, new or used.
Does that spell trouble for Sonic? Quite frankly, it might. However, if you have the stomach for speculation, you should consider the cynical angle.
Sonic Automotive Caters to Harsh Realities
While the Covid-19 crisis threw certain paradigms for a loop, the fact of the matter is that per Statista’s Global Consumer Survey, 76% of American commuters use their own car to move between home and work. At some point, businesses like Sonic Automotive may return to full relevancy.
But hold up — what about the permanent shift to work from home? Frankly, I have difficulty believing that companies will allow their employees to telecommute unless they mean handing out early retirement packages. With Elon Musk recently making noise about wanting his workers back in the office, the clock may be ticking on work-from-home privileges.
The second harsh reality that may suit SAH stock cynically well is that the cars on American roadways are older than ever; specifically 12.2 years according to an updated Wall Street Journal article.
To be fair, the above dynamic has forced households to consider repairing their rides rather than paying inflated rates for a new (or new to them) vehicle. However, at some point, the economics of auto repair don’t make much sense, especially for out-of-warranty cars.
In a way, you may consider the aging vehicle dynamic as pent-up potential demand. Once the pressure reaches the breaking point, SAH stock could potentially soar.
Not an Easy Road Trip
While there may be many positives about acquiring SAH stock at this juncture, I’m under no illusions. Based on the losses absorbed from the start of the year, I would be surprised if Sonic Automotive gets back into positive territory. So, no bonus points for me.
Nevertheless, for the contrarian investor who’s seeking a good deal right now, you might want to check out SAH stock. The financial metrics point largely in the right direction and while the fundamental narrative is risky, there’s some sensibility to it.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.