The automotive industry is typically not a place you'd look to find winning investment ideas. The industry is capital-intensive, cyclical, and produces low margins. That's not a recipe to make outsized long-term returns.
But there's one business in particular that has bucked this trend. I'm talking about Ferrari(NYSE: RACE). In the past five years, shares of this luxury car company have soared 216%, crushing the S&P 500 in spectacular fashion.
With the auto stock slightly off its all-time high, is now the time to add Ferrari to your portfolio?
Strong financials
The most relevant factor that has driven the gains for Ferrari investors is the company's impressive financials. Between 2018 and 2023, revenue increased at a compound annual rate of 11.8%, with adjusted operating income rising at a 14.4% annualized pace. At the end of the day, the objective is to sell more units at higher prices over time, something the business has been exceptional at.
It's worth mentioning that Ferrari faces durable demand. It's not quite as cyclical as traditional automakers, which register falling sales and earnings in recessionary periods. However, in 2020, when the pandemic shut factories temporarily, Ferrari reported an 8% sales dip. But the company was still ridiculously profitable.
Ferrari caters to the ultra-wealthy, a select group of people who are still able to afford these expensive cars in economic downturns. That reality reduces risk for investors. One doesn't need to waste time trying to figure out what direction interest rates or the economy are headed in. Ferrari does well regardless.
Powerful brand
Ferrari has been so successful from a financial perspective because of its strong brand presence. Thanks to its racing heritage that spans decades, coupled with unmatched skill in design and engineering, this business has a standing few can rival.
By being one of the world's most recognizable brands, one known for luxury and status, Ferrari has long been able to flex its pricing power. The average new vehicle will set you back the cost of a new home. And for Ferrari's more specialized models, the price can go into the millions. This helps explain the company's unbelievable 2023 gross margin of 50%.
The strategy isn't to maximize volume. Instead, it's to sell fewer vehicles than there is demand for them, creating that sense of exclusivity. To be clear, though, the number of cars Ferrari sells has climbed steadily over time. It totaled 13,663 in 2023, which was far fewer than companies like Ford, Tesla, and even Volkswagen's Porsche.
Consider the valuation
Ferrari sells some of the most expensive cars on the face of the planet. And right now, its valuation mimics this premium price tag. As of this writing, the stock trades at a price-to-earnings (P/E) ratio of 56.9. That's a significant premium to the historical average of 39. There's no discount going on here.
It wasn't always this way. Not long after Ferrari was first spun off from its parent, Fiat Chrysler, in 2016, shares carried an all-time low P/E multiple of 19.7 at the time. Perhaps the market wasn't totally familiar with just how lucrative the business was. That has changed in the past few years.
From an investment perspective, I can understand why some people would want to buy this stock. If paying an attractive valuation isn't a priority for you, but finding high-quality companies is, then Ferrari should be added to your portfolio.
I fall into a different camp. While I acknowledge that this is a wonderful business, I just can't get myself to pay such a steep valuation. I'll happily pass on the stock until there's a much more compelling entry price.
Should you invest $1,000 in Ferrari right now?
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Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Tesla and Volkswagen Ag. The Motley Fool has a disclosure policy.
