Auto Values The DAX in Overdrive

Handelsblatt’s companies and markets editor warns that the growing dominance of car companies on the DAX is putting the brakes on investor confidence.  
Quelle: dpa
Going up, up and away?
(Source: dpa)

Germany’s key stock market barometer, the DAX, finally made it. And it’s about time – Wall Street has been leading the way and showing how it’s done for some time now. But Germany's blue-chip index reached an all-time high at just under 12,500 points. At €1.3 trillion ($1.42 trillion). Germany’s 30 largest listed companies have never been worth as much.

But much more importantly, the 30 companies, which include Allianz, Siemens and Volkswagen, are generating profits, quarter by quarter, at a rate that keeps the stocks at a fair price. Each company, on average, is valued around 14 times as much as it is expected to earn this year. That is moderate and somewhat reduces the fear of a crash. Many companies and investors alike still have bad memories of the one that happened at the turn of the millennium.

Back then, the DAX climbed just above 8,000 points, but the companies were bringing in only around a third of their present earnings. That made the stocks expensive – and it was the major cause for the crash that had the DAX plunge by 75 percent at its peak. A disaster that left behind deep and permanent wounds: To this day, a good third of all German investors stay away from the exchange.

But the image of only a moderately-valued DAX today, giving no cause for concern, is unfortunately only half the story.

In fact, four car stocks dominate the DAX and distort the overall picture. After rapid increases, BMW, Daimler, Volkswagen, and the parts supplier Continental represent almost 45 percent of the total sales and a third of all the profits of all 30 companies. That may make the carmakers happy, but makes the DAX extremely dependent on the weal and woe of the automotive industry. If, for example, demand drops in China, where the carmakers sell more than a third of all their cars, it will not just be the businesses concerned that are threatened with problems, but the whole stock index.

If demand drops in China, it will not just be the carmakers that are threatened with problems, but the whole stock index.

What’s more is that the extremely low valuation of car stocks is a further result of investors avoiding them. Investors are paying only eight times the annual net profit for BMW and Daimler, for VW even only six times the profit. Underlying this is a deep distrust in the German carmakers’ business model. Despite Daimler having published a surprisingly strong quarterly after tax profit of €2.7 billion – twice as much as in the year prior – and combined this with a hike in its annual outlook, the stock went down a couple of cents in value. That’s not what you would call euphoria.

The way investors see it, today’s success is based on good business in the past and on outdated technologies. But the stock market likes to look to the future: What position would German carmakers be in if China were to suddenly impose a driving ban in its smog-infested cities and, perhaps, only permit electric cars? Such radical ideas are in no way far-fetched. Six million cars clog the streets of Beijing and pollute the air, so the government raffles off license plates for cars with combustion engines. The chance of getting one of the coveted plates is at around 50 percent.

This raises the question for investors: Will German producers play as big a role in the future in China as they do today? Or is it not much more probable that, due to their penchant for gasoline and diesel engines, international competitors like Toyota will come out on top? Could domestic Chinese producers promoted by the government, like Geely, backed-up with Volvo’s know-how, be the future winners in China?

Most investors have the suspicion that, going forward, German carmakers will be earning less than today – especially since they still one-sidedly focus on the gasoline and diesel engines that were yesterday and today are successful but will soon be obsolete. That explains the strong valuation haircuts for Daimler & Co. – despite their strong earnings.

Ultimately, car stocks distort the DAX and its appeal. Today’s investors contemplating entry into the stock market must know that the DAX, without its extremely cheap car shares, is not at all moderately valued but rather has drifted into the overpriced range. For investors are already paying more than 20 times the annual profits for quality shares like Adidas, Beiersdorf, Henkel, Fresenius, Linde and SAP. Even the chemical group BASF, which is vulnerable to cyclical fluctuations and therefore usually low-priced, now costs 17 times its annual profits. That is more than 30 percent above the long-term average – and is a dangerous signal calling for caution.

Simply put: without its cheap car stocks, the DAX is no longer low-priced - you might even say it's almost expensive.