Better Buy: Toyota Motor vs. Volkswagen AG

Auto stocks are a tough sell when concerns about the economy are rising, as they are now. Most investors know that auto sales are cyclical, rising and falling with consumer confidence -- and automakers' profits and stock prices tend to follow sales cycles.

That said, most investors also know that sometimes we can find good value by looking closely at sectors that are out of favor, as autos are now. Below, we'll take a close look at two global giants, Toyota (NYSE:TM) and Volkswagen (OTC:VWAGY), to see if either looks like a good value right now.

Valuation and stock performance

Most auto stocks, including Toyota and Volkswagen, had a rough time in the fourth quarter of 2018. Both have recovered somewhat since the beginning of 2019. But while Volkswagen's share price has had a bumpy ride, Toyota's followed a smoother upward course, at least until recently:

Better Buy: Toyota Motor vs. Volkswagen AG
VWAGY data by YCharts.

What about valuation? The historical norm for auto stocks in good times is a valuation of around 10 times earnings. Right now, Toyota is trading at about 10.8 times its earnings over the past 12 months, while Volkswagen is trading at just 6.3 times its earnings over the same period.

Both stocks look somewhat less expensive when we compare their prices to forward earnings estimates, as analysts expect both companies to post improved earnings in the current fiscal year. On that basis, Toyota is trading around 8.9 times its expected earnings, while Volkswagen is trading at about 5.5 times forward earnings.

On both measures, Volkswagen has the advantage from a value perspective.

Dividends: How Volkswagen and Toyota compare

Like many Japanese companies, Toyota uses a fiscal year that ends on March 31. In its most recent fiscal year, it paid total dividends of 220 yen ($2.05) per share, unchanged from the year prior. That translates to a dividend yield of roughly 3.2% at current prices.

Volkswagen pays a dividend once a year, after its annual meeting in May. This year's dividend on "ordinary shares," or common stock, was 4.80 euros ($5.27), up from 3.90 euros in 2018. That translates to a dividend yield of about 3.2%, roughly matching Toyota's.

Better Buy: Toyota Motor vs. Volkswagen AG
VW is hoping that a series of charismatic new electric vehicles will help it move past the diesel scandal. Image source: Volkswagen AG.

Growth and potential risk

Toyota and Volkswagen are both giants in their respective homelands -- not only in terms of size and revenue, but also in terms of employment.

As of June 30, Volkswagen employed almost 292,000 people in Germany, making it the country's largest employer by far. Toyota has similar status in Japan: It directly employed about 214,000 people in Japan as of March 31, with many thousands more employed by companies in the so-called "Toyota Group," a loosely structured conglomerate that includes many of the auto giant's leading suppliers.

That has important implications for both the risk and the potential for growth for each company. On the one hand, as huge employers, both companies enjoy some protection from their respective home governments -- put simply, they're probably "too big to fail." But that protection comes with a price: Political pressures make it difficult for both to cut jobs in their home countries, even (maybe especially) during challenging economic periods.

For investors, that's a mixed bag: Both stocks are likely to be somewhat less volatile than those of most of their peers, but both companies have limited ability to cut costs in their huge domestic operations. Both are working to reduce costs now, and they've both had some success over the last year or so -- but further gains are likely to be incremental, not dramatic.

More than any other large global automaker, Volkswagen has moved aggressively to transition to electric vehicles: It hopes to be selling about 3 million battery-electric vehicles per year by 2025. If all goes well, it expects that its operating margin will rise to between 7% and 8% by then, from 5.9% in 2018. But it will have to spend billions of euros to get there.

Toyota's plan is more incremental. Right now, it's working to move most of its vehicles to a shared architecture, to reduce costs and increase flexibility, while making smaller investments in electric-vehicle technology and advanced driver-assist systems. It seems like a conservative strategy, and it is -- but Toyota's history suggests that it will have the technologies it needs to remain competitive when they become necessary.

Better Buy: Toyota Motor vs. Volkswagen AG
CEO Akio Toyoda has pushed Toyota to make more exciting products while trimming costs and investing in advanced technology. Image source: Toyota.

To sum up: Both companies are making substantial investments in driverless-vehicle technology, alternative "mobility"-related businesses, and electric drivetrain technology. Both are very good bets to remain competitive as the auto industry evolves, though it's too early to say how any of those areas will affect their bottom lines over time.

Which company is the better buy now?

Truth be told, Toyota and Volkswagen have a lot in common. Both are solidly profitable, are managed well (if a bit conservatively) at the moment, and are doing the right things to prepare for the future.

But lingering issues related to its 2015 diesel-emissions scandal have kept Volkswagen's share price down somewhat, making it the better value right now. VW may not be completely done with the diesel scandal's consequences, but it's clearly closer to the end of that mess than to the beginning -- and with the first of a wave of electric vehicles now coming to market, its future is looking pretty bright.

It's always a risk to buy an auto stock late in the cycle. But of the two, I think Volkswagen is the better place for new money right now.

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