Contrary call to buy Toyota (TM)

by Ian Wyatt, editor Top Stock Insights

Everyone likes to find a bargain, and those of us that invest in stocks are no different. I am always on the lookout for great a company trading at a healthy discount. If we have learned anything from the past few years it's that good companies can have bad quarters and see their stock price fall.

When I'm bargain hunting I will always keep in mind two things. First, why is the stock trading at a discount? Second, can the company recover? If the company can recover from the problem quickly, then I will buy that stock. Such is the case with Toyota Motor Company (NYSE: TM).

Recalls are always costly for a company. The obvious costs are related to replacing the product, or in some instances paying for damages caused by the product. In addition to the car recall, Toyota may also have to change assembly lines or order new parts. This will delay new car production, which may result in lost sales.

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Another cost that is less obvious is the damage done to the brand name. For car makers brand image is even more important. Successful product brands take decades to build so protecting that image is top priority.

These costs associated to recalls always translate into losses for shareholders. The losses usually happen fast as investors become restless holding onto shares. For good companies, share losses will be temporary and are a great time to initiate a position.

Aside from a minor blip in 2009, Toyota has grown sales every year for the past decade. In fact, even with the decline in fiscal 2009, total sales have more than doubled to $207.9 billion from $103.3 billion in fiscal 2001. Known for its efficiency, the company has also been profitable every year in the past decade except for 2009.

Analysts have had a heck of a time trying to figure out how the company's financial results will be impacted by these recalls. Next year, even with the recall, the company is widely expected to be profitable. Analysts predict from $1.57 to $4.80 per share.

With $30 billion in cash sitting on the balance sheet in cash equivalents and a superior AA credit rating, I have no doubt the company will have the resources necessary to cope with any near term sales problems. As a result, I am not going to worry about this year's results, which will include a number of expense provisions associated with the product recall.

Next year's results will also be volatile, but overall, I think the analysts have over reacted to the current troubles. Additionally, a recovering global economy should increase consumer spending and a rising dollar/yen will increase demand for Japanese goods. The overreaction and economic trends lead me to think that Toyota will produce, or even exceed, the high-end estimate of $4.80 per share.

Toyota is not a fast growing company, but it is a clear leader in the industry. I typically want to invest in companies that are able to grow sales at a double digit pace year over year. A high growth rate suggests that the company has a product that is in high demand.

Increasing growth rates are even better because that indicates demand and price are both increasing for the product. In Toyota's situation, slow growth is not an issue because the car manufacturing industry has a number of barriers to entry, most notably initial startup costs. It takes decades for a new threat to emerge that could take on existing manufacturers.

Additionally, Toyota's focus on quality has given the company a clear advantage over the current competition. Although its brand is undergoing near term scrutiny, management's fast response to the recall has stabilized the damage.

Management will now focus on rebuilding the company's edge on quality even if that means slower growth in the short term. I have no doubt that the near term for Toyota and its shareholders will be volatile, but I like the idea of buying the world's number on auto maker at a 16% discount based on a temporary recall that is likely to be in the rear view mirror in 6 months.

Learn more about this financial newsletter at Ian Wyatt's Top Stock Insights.