Magna International (TSX: MG) and Linamar (TSX: LNR) are auto part suppliers with cyclical businesses. So, their stocks have above-average volatility. As well, their valuations can change for the better or worse more often. For example, analysts can downgrade the cyclical stocks, as an upcoming recession is expected in Canada and the United States, and that could result in their weaker business performance.
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Valuation
Right now, analysts have a consensus 12-month price target of $86.62 for Magna. This equates to a discount of 21% at $67.99 per share, which is about 12 times earnings. In other words, analysts currently think the stock has a 12-month upside potential of about 27%.
For Linamar, analysts currently have a consensus 12-month price target of $86. At $63.08 per share at writing, it equates to a discount of 27% and a bigger margin of safety versus Magna. The recent quotation suggests a valuation of about 9.2 times earnings. In other words, analysts currently think the stock is more undervalued than Magna and has near-term upside potential of about 36%.
Why Magna stock commands a premium valuation
Magna stock commands a premium valuation to Linamar. First, it’s a bigger company with a larger scale. Last year, it generated revenue of US$37.8 billion, resulting in operating income of US$1.6 billion. The company is also awarded a solid S&P credit rating of A-, whereas Linamar is not rated (though its financial position appears to be solid).
Second, Magna has paid an increasing dividend for 13 consecutive years with a respectable 10-year dividend-growth rate of 12.6%. Third, its dividend yield of close to 3.7% is decent compared to Linamar’s small dividend yield of about 1.4%.
Magna’s dividend growth was relatively low at a compound annual growth rate of 3.4% in the last couple of years, as its payout ratio expanded to approximately 87% of net income in the trailing 12 months (TTM).
In comparison, Linamar generated $7.9 billion in revenue last year, while its operating income was $565 million. The company cut its dividend by half during the pandemic year of 2020 but more than recovered the dividend in a year. It has increased its dividend for two consecutive years with a 10-year dividend-growth rate of 9.6% per year. Its TTM payout ratio is only about 12% of net income.
Which is a better buy?
In the last 10 years, Magna stock delivered annualized returns of about 10.5%, while Linamar’s total returns were roughly 10.9%. Perhaps Linamar is able to grow at a faster pace, because it’s growing from a smaller base, which helped it drive slightly higher returns than its bigger peer. You’ll notice that Linamar also managed to get higher margins. For example, its TTM operating margin was 7.1% versus Magna’s 4.2%.
In any case, both stocks delivered market-beating returns in the last decade for the above-average market volatility investors endured while holding these stocks. Some investors might feel more comfortable holding Magna stock, which provides greater income from its higher dividend yield.
Because they are cyclical stocks, active investing with excellent market timing could lead to extraordinary returns, particularly in Linamar stock. The idea is to buy the stocks at lows, when there’s bad news and sell them after economic expansions occur.
Currently, Linamar’s technical chart appears to be a tad more positive than Magna’s. So, active investors who can stomach the risk could consider taking a closer look at Linamar, which is more undervalued. If you prefer to get more regular returns from dividends, you can investigate further in Magna.
