The downturn is likely to be a tremendous entry point for investors – nevertheless it needs to be a risk

Ford (NYSE:F) stock has slumped 20% to $11 within the times following the automaker’s second-quarter 2024 financial results. Ford admitted to having quality-related issues with vehicles from 2021 and earlier, so investors should wait for further motion from the company before considering buying the dip in Ford stock.

The temptation for value investors to grab some shares shall be strong. Ford’s trailing 12-month price-to-earnings (P/E) ratio is around 11.5, so it’s easy to conclude that Ford shares are low price immediately.

Nevertheless, it’s hasty to buy seemingly low price Ford stock when there’s a significant, unanswered query: can Ford regain its repute for producing reliable cars and trucks that don’t incur high warranty costs?

Ford’s surprisingly rough quarter

The 20% slump in Ford stock could appear extreme, nevertheless it’s not entirely unjustified. In any case, Ford’s second quarter results in 2024 were worse than anticipated.

Admittedly, not all of the knowledge points were bad. Particularly, Ford’s revenue grew 6.2% yr over yr to $47.8 billion.

Nevertheless, the automaker’s bottom-line results were definitely subpar. The company’s operating profit fell 26% yr over yr to $2.8 billion. The underside operating-profit estimate, per FactSet data, was $2.9 billion, so Ford’s $2.8 billion was a major shock.

Furthermore, Ford’s adjusted earnings of $0.47 per share came in far in need of Wall Street’s call for $0.67 per share. Because of this fact, even when Ford stock at $11 may be tempting, it could take the market a while to digest the negative bottom-line quarter data and forgive Ford for falling to this point in need of Wall Street’s expectations.

Vehicle quality issues lead to high warranty costs

Vehicle quality is a costly issue for Ford. The automaker’s second-quarter warranty-related expenses increased $800 million over the first quarter to around $2 billion, translating to 4% of Ford’s sales.

Furthermore, Ford spent a whopping $4.8 billion fixing its customers’ vehicles in 2023, in accordance with Warranty Week magazine (via Bloomberg). For context, that rate is about 3 times greater than the industry average vehicle-repair cost.

CEO Jim Farley tried to reassure investors about vehicle quality. He assured that Ford is currently “testing vehicles to failure” and running them “at extremely high mileage” to detect quality-related issues.

That’s not much reassurance for the short term, though. Per Bloomberg, it’s going to “take as long as 18 months to see the benefits of that recent process show up in lower warranty costs” for Ford.

Farley added that these measures make the firm’s quarters “lumpy”, but that it’s going to scale back warranty over time. Nevertheless, judging by the 20% drop in stock price, the market hasn’t put much faith in the concept that things will only get better for Ford.

In point of fact, it looks like Wall Street experts aren’t pinning their hopes on Farley’s assumption of a greater future. For instance, Barclays analyst Dan Levy complained that “the warranty challenges are frustrating for investors, as they follow many other warranty issues in past years and at times drag results unexpectedly”.

Similarly, Freedom Capital Markets analyst Mike Ward observed that “warranty has been a growing issue at Ford in the course of the last five years and has escalated over the past yr”.

Thus, it appears that evidently Wall Street wants more evidence of Ford’s vehicle-quality improvement.

Ford’s repute at stake

A big automaker like Ford has handled many problems through the years, including last yr’s autoworkers’ strike. Nevertheless, persistently substandard automobile quality is unacceptable, because it’s going to wreck the firm’s repute if it continues.

Because of this fact, investors shouldn’t just take Farley’s word for it when he implies that the warranty-cost situation will improve. Until this improvement shows up in the knowledge, which is in a position to require as a minimum one other quarter or two, it’s smart to treat Ford as a “show-me story” and Ford stock as a dip that shouldn’t be bought yet.