Harley-Davidson stock: Take a ride, but wear a helmet
— -- A: I hope investors in motorcycle maker Harley-Davidson have been wearing their helmets.
Shares have skidded as Harley deals with a drop in revenue resulting from a weak economy. The stock is down nearly 80% from its highs in November 2006 and is off about 50% in the past year.
Does the wipeout mean it's time for you to saddle up and take Harley for a spin in your portfolio? To find out, I'll put the stock through the four tests we consider at Ask Matt:
Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading Harley's trading history back to 1986, we see the company generated an average annual compound rate of price appreciation of 26.3%. This is a high return; the S&P 500 posted an 8.9% average annual return in the same time frame, says IFA.com.
If you owned Harley, you accepted risk — standard deviation — of 42.9 percentage points. That's much higher than the 15.8 percentage point risk of the S&P 500 during the period. But for 171% higher risk, you got a 196% higher return. That makes Harley, despite the nerve-rattling risk, one of the few stocks that justifies its volatility with a market-beating return.
Step 2: Measure the stock's discounted cash flow. Some investors decide if a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs. When I run Harley's stock, I find it's rated "very attractive." In other words, the stock is inexpensive relative to the cash the company is expected to generate over its lifetime.
Step 3: Compare the stock's current valuation to its historical range. BetterInvesting's Stock Selection Guide can help. If the company can increase earnings 10% a year the next five years, as analysts expect, that would put the stock in the "buy" range. That's a green light for investors who believe the price-to-earnings ratio will return to historical norms. Investors must also believe the company can maintain a high growth rate.
