Summary
GM shares have had an impressive year
Management has a long-term strategy to take advantage of electric vehicles and autonomous driving
Despite the optimistic long-term outlook, investors should be ready for short-term volatility, with a possible drop towards $56 in the coming weeks.
Investors in General Motors (NYSE:) stocks have had a great year so far. The share has so far increased almost 40%.
The Detroit-based automaker will report its second quarter earnings on Aug. 4. While we expect the stock to be volatile until then, long-term investors with a time horizon of two to three years should consider investing in GM stocks now. Here's why.
Long-term tailwind for GM stocks
With a history dating back to 1908, General Motors has produced iconic car brands for many decades. Nevertheless, 2020 brought challenges for GM and its automotive colleagues due to the pandemic. The industry is also struggling with the recent shortage of chips.
Global Electric Vehicle Sales and Growth 2018-2020
Map courtesy of ev-volumes.com
On the other side of the equation, investor interest in electric vehicles and alternative energy has peaked over the past year. In 2020, more than 3 million electric vehicles were sold worldwide. Most investors consider Tesla (NASDAQ:) arguably the most successful name on the road to automotive electrification.
However, more established automakers such as Ford (NYSE:) and General Motors are also joining the EV revolution.
General Motors announced in early May. Revenue remained nearly stable at $32.5 billion. In contrast, net income rose to $3.0 billion in the first quarter of 2021, from $0.3 billion in the first quarter of 2020. Adjusted diluted earnings per share came in at $2.25.
About the results, CEO Mary Barra commented:
"While we will have production shutdown in the second quarter, we expect a strong first half. We also reconfirm our full year outlook."
So, despite the semiconductor shortage, General Motors reiterated its full-year outlook for 2021. It expects to achieve net income of $6.8 billion – $7.6 billion, or an adjusted diluted EPS of between $4.50-5.25.
In recent months, management has emphasized that the company will devote significant resources to the growth of electric vehicles.
Shareholders are delighted with the direction the company is taking.
Long-term GM investors were also excited about "Cruise," the autonomous driving company partially owned by General Motors. Other partners in the company are Microsoft (NASDAQ:), Honda (NYSE:), Softbank (OTC:) and Walmart ( NYSE:).
In the past 12 months, GM's share has bounced back about 115%. The stock closed at $58 on Wednesday.
Among 21 analysts surveyed via Investing.com, they were predicted to "outperform." With a 12-month average price target of $72.25, that would mean a return of over 22%.
The stock's lagging P/E, P/S and P/B ratios are at 9.5, 0.7 and 1.82 respectively. In comparison, Tesla's trailing P/E, P/S and P/B ratios are 673.71, 17.92 and 27.97.
In summary, Wall Street is optimistic about General Motors. We also believe that GM stocks look attractive from a value standpoint. Combined with management's position on EVs and autonomous driving, we believe the stock should be part of a long-term portfolio. in the long run, there could be several headwinds for the stock in the short term, especially between now and when the company announces earnings before the opening on Wednesday, July 28.
Chart: .com investing
Investors looking at technical charts may be interested to know that GM stocks may trade sideways in the coming weeks, especially between $55 and $60.
Since early June, the shares have lost about 10% of their value, providing a better entry point for buy-and-hold investors. However, there could still be a further drop to the $56 level, or even lower.
We should also note that the beta (?) of GM is 1.33, a measure of the volatility of a security relative to the overall market.
So a company like GM where ? is greater than 1 is more volatile than the market. With a beta of 1.33, GM has a volatility that is 33% higher than the market average. In other words, we should expect price fluctuations, especially in the short term.
As part of the near-term sentiment analysis, it would be important to look at implied volatility levels for GM options. Implied volatility typically shows traders the market's view of possible moves in a security, but it does not predict the direction of the move.
GM's current IV is 33.2, which is above the 20-day moving average of 30.9. In other words, implied volatility is on an upward trend.
In short, charts and options markets urge caution. Given the high beta of GM stocks, we can expect price swings. Our first expectation is a potential pullback towards $56. In the event of such a drop, long-term investors would find better value.
Possible Trades
For readers who believe that General Motors still has room to run higher, they may want to add GM stocks to their long-term portfolios.
Depending on individual portfolio allocations and risk/return profiles, there are three types of trades here. These trades are based on the intraday price of GM stock of $58.96 on July 14. Please note that several of the calculations below do not include trading fees or taxes.
1. Buy GM stocks at current levels:
Investors who are not concerned with daily price movements and who do not want to wait for a possible decline of about 5%-7% from current levels may consider buying invest in GM stock now.
Such buy-and-hold investors should hold this long position for several months, while GM stocks may still attempt to hit all-time highs of $64.30 and above.
Assuming an investor enters this trade at the current price of $58.96 and exits at $64.30, the return would be just over 9%.
Investors may also consider placing a stop loss at approximately 3% below their entry point.
2. Buy a LEAPS option as a 'surrogate' for owning GM stock: Investors who want to buy 100 shares of GM stock must invest $5,896 (current price of $58.96 X 100 shares).
For some investors optimistic about General Motors, this can be a significant investment. Instead, they might consider buying a LEAPS call with a delta of 0.80, such as the GM January 20, 2023, 45 strike call option. This option is currently offered for $17.80.
Here we have discussed the mechanics and risk-return profile of LEAPS. But in simple terms, the delta rating shows the amount that an option's price is expected to move based on a $1 change in the underlying security.
In this case, if GM stock rose $1 to $59.96, the current $17.80 option price would be expected to rise 80 cents based on a delta of 0.80. However, the actual change may be slightly more or less, based on several other factors.
The profit/loss profile of this trade will continue to vary as the price of the underlying GM options changes. However, on January 20, it would break even at an underlying price of $62.80. To arrive at this number, one can add the current option premium of $17.80 to the strike price of $45.00, i.e. $62.80.
The maximum return on the upside would be unlimited depending on where GM stocks trade on the day the investor closes the position.
Investors should remember that although the expiration date is in January 2023, this long-term option still expires. As the expiration date approaches, an option loses value faster and faster. If GM stock tanked and closed below $45 in January 2023, the maximum loss would be $1,780. Trade management will therefore be important for those who decide to set up a LEAPS strategy.
3. Sell ??a cash secured put option:
Our third trade is a cash secured put strategy. We've covered this option in numerous articles recently. Here is an example.
Traders can now sell a 57.50-strike put option on September 17, which is currently offered for $3.18.
Assuming traders would enter this sell strategy at current prices, the advantage is that this $318 premium is maintained as long as GM shares close above $57.50, when the option expires. Although $318 would be the maximum return for this trade.
The downside is that if GM stock trades below $57.50 before maturity, traders can get 100 shares for each put sold at a cost of $57.50 per share.
At maturity, this trade would break even at a stock price of $54.32 (i.e. $57.50-$3.18).
Bottom Line
General Motors is aggressively investing in EV technology and management is eager to build on the current momentum in the alternative energy market. As a result, GM's stock, which has had a strong year, could continue to offer significant gains in the quarters ahead. However, there is likely to be some volatility before the next bull leg begins.
