Americans still have a healthy obsession with cars. That was on display last week, with February car sales beating the most optimistic projections for the second month in a row, while rising to their best level in more than four years. According to research firm Autodata, annual sales, a closely followed industry benchmark, rose to 15 million units in 2012, the best pace since 2008, before the financial crisis crushed demand and threw the industry into turmoil.
Clearly, in spite of rising gasoline prices and the payroll tax increase from the "fiscal cliff," cars are still quite popular, taking priority over debt payment or vacation for most Americans.
And this passion for cars is creating an opportunity for investors to profit in a big way.
An easy route to take when investing in the automobile industry would be buying stocks like Toyota (NYSE: TM) and Ford Motor Co. (NYSE: F). But automakers are vulnerable to the whim of the consumer, where old models can quickly fall out of favor and new models require heavy investments in research and development.
That's why my favorite way to invest in the booming auto industry is with auto-parts makers. Auto-parts companies offer two distinct benefits over the automakers.
The first is pricing power. While a huge bevy of manufacturers compete for limited consumer dollars, frequently leading to pricing wars and margin erosion, there are fewer auto-parts specialists for manufacturers to choose from. This gives auto-parts makers more pricing power and margin strength than the car makers.
The second benefit is diversification. Auto-parts companies sell their components to every car manufacturer under the sun. This means their balance sheets don't rest with the success of last-year's best seller or this year's hottest new model. Selling to a wide swath of car manufacturers protects auto-part makers from manufacturer and car-specific risks.
But even though auto-parts companies are less known than high-profile automakers, there are plenty of good stocks to choose from. Here is a list of my top six.
TRW Automotive Holdings Corp.
TRW supplies auto systems, modules and components to automotive original equipment manufacturers (OEM). With car sales booming, shares have been hot, up a market-beating 32% in the past year. These gains have been fueled by impressive earnings growth, with the company beating earnings estimates by an average of 8.5% in the last four quarters.
Looking forward, analysts are projecting annual earnings growth of about 9.5% in the next five years. And in spite of this bullish growth projection, TRW still looks a bit undervalued, with its forward P/E (price-to-earnings) ratio of 9 below its 10-year and peer average of 10.
Dana Holding Corp.
The company designs and manufactures driveline products and technologies for vehicle manufacturers worldwide. Despite the company's more than 100-year history, dating back to 1904, Dana is the smallest company on the list, with a market cap of just $2.6 billion. Dana has also been benefiting from renewed strength in auto sales, with shares climbing 21% in the past six months. Analysts are calling for earnings growth of 9% in 2013 and another 11% in 2014. Its projected five-year growth rate of 12% is ahead of the projected industry average of 11%.
Dana also has value, trading with a forward P/E (price-to-earnings) ratio of 9, below its peer average of 11. And when you throw in its 1.2% dividend yield, Dana is a solid pick to capitalize on resurgent car sales.
Risks to Consider: Higher payroll taxes and gasoline prices have created some uncertainty around discretionary consumer spending. Although sentiment has been holding up well so far, that could change heading into summer if gasoline prices continue to rise.
Action to Take -- Car sales continue to rebound from their epic collapse during the financial crisis of 2008, almost back to peak levels of 16 million annual units. But even though car manufacturers are benefiting from the trend, the best way to capitalize is by investing in auto-parts manufacturers. With more margin strength and diversification, these companies are in position to continue to gain further on the bullish trend in car sales. From the six auto-parts makers listed here, my two favorite are TRW Automotive and Dana Holding Corp. because of their bullish growth projections and attractive valuations.
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