This business looks more like a luxury brand than a typical car maker.
Investors might be inclined to look at past winners to find potentially lucrative stock options to own going forward. Winners will keep on winning, as the thinking goes.
Ferrari (RACE 4.88%), one of the world’s leading manufacturers of supercars, has certainly supercharged shareholder returns. In the past five years, this phenomenal auto stock has soared 166% (as of Aug. 9), beating the broader S&P 500 by a mile.
But is it too late to add Ferrari to your portfolio?
Ferrari is a special business
There’s really no argument about Ferrari being a high-quality enterprise. While there are many supporting factors, it all starts with a strong fundamental performance.
In the past several years, Ferrari has put up some stellar numbers. Between 2018 and 2023, revenue increased at a compound annual rate of 11.8%. The most recent quarter (2024’s second quarter ended June 30) saw a year-over-year sales jump of 16.2%.
That top-line growth is impressive. But what stands out is the strong bottom-line gains that have accompanied it. Ferrari boasts a fantastic operating margin of 29.9%. Combined with ongoing share buybacks, adjusted-diluted earnings per share (EPS) in Q2 were 139% higher than the same period in 2019.
Besides its financial performance, there are other compelling characteristics that make Ferrari a truly special business. The brand is the company’s most critical asset, supporting its wide economic moat. Bolstered by Ferrari’s rich racing heritage and unmatched product performance and design, it has been fostered over many decades. I think it would be impossible for anyone to try and replicate this brand’s power.
Make no mistake about it: Ferrari is a luxury brand. Management intentionally produces a limited quantity of vehicles year in and year out to keep demand robust. There’s no question that the business could, if it wanted to, make more cars, and in the process rake in more sales and earnings. But this just isn’t the right strategy, as it would harm the brand image.
Consequently, Ferrari has incredible pricing power. Some of its most exclusive models sell for seven-figure sums, with strong demand from buyers. Warren Buffett, viewed by many as the greatest investor ever, believes that pricing power is one of the most important factors that identifies a good company. Ferrari is in an elite category in this regard.
This is also a business that can help its shareholders sleep well at night. Ferrari faces minimal threats of disruption. Compared to nearly all companies out there, this one is better protected from macroheadwinds, like inflationary pressures and recessions. Ferrari just keeps humming along no matter what is going on.
Where is the opportunity?
There’s so much to like about this company. Anyone who takes the time to learn about and understand Ferrari would come away impressed.
But this doesn’t mean that the stock is an automatic buy. The market is fully aware of Ferrari’s best attributes. And because of this familiarity, shares trade at a price-to-earnings (P/E) ratio of 51. This valuation is too rich for my blood, no matter how wonderful the business is.
Wall Street consensus-analyst estimates say that EPS will rise at an annualized pace of just 12% between 2023 and 2026. There is no way that this projection justifies paying such a steep valuation. Investors who decide to buy shares today are betting that the valuation won’t come down, which is hard to believe given that the S&P trades at a price-to-earnings (P/E) multiple less than half that of Ferrari.
I think the best course of action is simply to add Ferrari to the watch list. And then wait patiently for a much better entry point. For me, this means the P/E ratio would likely have to drop to somewhere around 35.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
