The Best Way to Profit From The Car Sales Boom
Last week’s news that auto sales jumped 0.7% in June suggests the economy is gaining strength. Cars aren’t cheap. An entry-level vehicle will set you back $20,000 or more, and the average mid-size sedan costs around $36,000.
Consumers don’t part with that kind of money unless they are confident they will remain gainfully employed. The unemployment rate is as low as it has been in decades, and wages are growing faster than inflation.
That’s the good news. The bad news for the auto industry is that sales for the first half of this year were the lowest since 2014. But if the economy continues to strengthen and the Federal Reserve cuts interest rates, the second half of this year could be one of the strongest in years.
That’s why I think it makes sense to take a hard look at Ford (NYSE: F) right now. Currently trading below $11, Ford is a low-cost, low-risk way to play the improving American auto sector.
In a moment, I’ll explain one way to do that. But first, I’d like to share with you one of the most successful trades I ever made in my life that involved Ford stock.
The Trade of a Lifetime
Ten years ago, the global economy was in shambles. The stock market had lost half its value, and the unemployment rate spiked to 10%.
Comparisons to the Great Depression were being made, when unemployment soared to 25% and the stock market lost 90% of its value.
At the same time, car sales plummeted.
Like everyone else during the Great Recession of 2008-2009, I wasn’t sure if the stock market had bottomed out. But I was certain that our government would not let our domestic auto industry go under.
Of the “Big Three” U.S. automakers, I felt Ford was the financially strongest and least likely to go bankrupt. Regardless, its share price fell below $2 as investors panicked.
That was my cue to take action.
I figured I’d have to wait several years until I could cash in on this investment. Instead, Ford quickly soared above $10 and I sold my shares less than a year after buying them.
Turns out, I should have held out a little longer. Within two years, Ford rose above $15. Since then, it has slowly fallen back to about the same price at which I sold it nine years ago.
Now, I sense a similar opportunity to profit from Ford. But this time, the way the play it is different.
A Better Option
Instead of buying Ford stock, this time I’ll buy a LEAP on it. A LEAP is a call option that has more than a year until expiration.
For only a dollar more than what I paid for a share of Ford stock 10 years ago, I can buy a LEAP that expires in January 2021 with a strike price of $7. That means over the next 18 months I can buy shares of Ford for $7 no matter what its market value.
That puts my breakeven point at $10.50, which is the cost of buying the LEAP for $3.50 plus exercising it at a share price of $7.
Let’s say Ford rises to $15 by the time my LEAP expires. That would result in a net profit of $4.50 ($15 minus $10.50), which equates to a gain of roughly 128%.
That’s less than the fourfold gain I booked nine years ago. But it’s a more likely scenario to double my money than buying Ford stock outright and hoping it goes all the way up to $21.
Of course, there is an offsetting risk by doing it this way. If Ford drops below $7 by the time my LEAP expires, I could lose everything.
I don’t think that is likely. But for that reason, I only risk what I can afford to lose if this trade goes south on me.
We will soon know if Ford participated in last month’s surge in car sales. This week, the company will release its Q2 results.
I’m not expecting fireworks, but anything other than bad news could push Ford’s share price above $11. Currently valued at less than eight times forward earnings, Ford stock is cheap.
It’s also a cash cow. Earlier this month, Ford declared its fifteenth straight quarterly cash dividend of 15 cents. That works out to a forward annual dividend yield of 5.7%.
I’d be happy to own Ford stock for that reason alone. But in this case, I think there is much greater upside potential in buying the LEAPs.
With the stock market at record highs, I believe there is more money to be made trading this way than with a traditional buy and hold approach.
It’s unlikely the stock market will gain another 25% over the next year. But you don’t have to settle for mediocre gains. My colleague Jim Fink consistently racks up triple digit gains.
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