The valuation game - What recent automotive transactions and ESG-Criteria tell us about current automotive stock valuations

Lesson #1 – Identify the hidden value of future potential

For an index to be truly representative of an industry as complex as automotive, it needs to protect against the bias inherent in under- and overvalued stocks. The WisdomTree Global Automotive Innovators index does this by assessing a company’s strategy, value network and investor sentiment, as well as its core financials. This means stock selection is based on overall performance, not current market valuations. The index share of any one stock is also capped at maximum 2.5 percent at each rebalancing.

The WisdomTree Global Automotive Innovators index further over-represents the stocks of newcomers that have the potential to be more influential in shaping the automotive future than their present-day valuation suggests. In an industry that has often been re-shaped by hidden champions, we believe this approach makes the index a true indicator of the automotive future.

Lesson #2 – OEMs are not the only winners

In 2021, many OEMs posted record profits. However, on the WisdomTree Global Automotive Innovators index, dealer groups have clearly outperformed manufacturers since at least beginning of 2021, indicating that they were able to pocket a bigger share of the additional earnings that resulted from offering fewer customer discounts amid global production shortages.

Margins are always a function of the relative bargaining power of the different players that make up an industry’s value chain. Although the vehicle shortage will be a temporary phenomenon, OEMs should take cues from the strong performance of their retailers to manage business risks more actively themselves rather than offload them on to their suppliers and business partners. Only thus can OEMs ensure they get the full upside potential too.

Lesson #3 – Japanese automotive companies have the momentum

The pace of recovery from the combined effects of Covid-19 and global supply shortages remains very uneven across the world’s leading automotive manufacturing regions. Japanese auto companies (OEMs and suppliers alike) were relatively late in their recovery but have shown the strongest growth momentum over recent months, and are now attracting significantly higher valuations than German OEMs, for example. It seems that their Japan-centered supply chains prove more resilient in the current crisis than do the European OEMs’ globally more fully integrated supply networks.

Lesson #4 – IPOs aren’t the only way to avoid being hit by a “conglomerate discount”

Part of the reason that German OEMs remain undervalued is that capital markets have come to dislike industrial conglomerates. Both the Daimler truck spin-off and the Porsche IPO can be seen as evidence of OEMs trying to respond to this change in investor expectations.

It is worth noting then, that the index shows that breaking themselves up is not the only way OEMs can avoid paying a conglomerate discount. China’s Geely has succeeded in convincing investors of the advantages of operating through a single holding structure. In other areas of the automobility ecosystem – notably battery cell and chip production and vehicle software development – capital markets actually reward a high degree of integration. This is because these areas will shape the automotive future to a much greater extent than other, more traditional areas of automotive value creation.  

Lesson #5 – ESG will evolve from a screening factor to a key differentiator

Currently, the WisdomTree Berylls LeanVal Global Automotive Innovators index uses ESG criteria only as a screening factor. In part this is because there is not yet a complete and universally accepted set of ESG investment criteria.

However, we’re already seeing a strong correlation between ESG scores and stock performance among the 100 index companies. Our sentiment analysis shows that investors see ESG compliance as an indirect indicator of a company’s willingness to innovate as well as a direct indicator of a company’s ability to mitigate business risks.

The influence of ESG criteria shows that many investors are already looking beyond fundamentals to build a more accurate picture of a company’s value and growth potential. Strong ESG commitments are likely to become even more important in the future, and the links investors are drawing with innovation and risk management make clear the massive transformation that has already started in the way automotive stocks are valued.