How Will the Recall Issue Affect GM Stock?

Submitted by George Putnam, III as part of our contributors program.

How Will the Recall Issue Affect GM Stock?

Because General Motors (GM) is currently the subject of many negative headlines arising from a significant recall relating to ignition switches, we wondered what long-term effect the recall would have on GM’s stock. Our best guess is “very little.”

As contrarian investors here at The Turnaround Letter, we like to “buy on bad news.” We’ve looked at a number of product liability issues over the years, going back as far as the exploding gas tanks on Ford Pintos in the 1970’s. Our general conclusion is that once the negative headlines subside, even major product liability issues have little long-term effect on stock price. The one major exception has been for asbestos-related liabilities, which usually have a devastating effect on the company’s common stock.

We decided to test that conclusion with a relatively recent example. In late 2009 and early 2010 Toyota issued a series of recalls relating to sticking accelerator pedals. Just this past week, Toyota agreed to pay a $1.2 billion fine to the U.S. government arising from the accelerator issue—and that is on top of a $1.1 billion class action settlement with private litigants late last year.

So what happened to the Toyota stock? From the end of February 2010 (which is the month after the recalls peaked) to March 25, 2014, Toyota stock has gained 45%. This compares to a gain of 31% for Ford stock and virtually no gain for Honda stock over the same period.

Obviously, many factors affect a stock’s long-term performance, but our conclusion is that liability relating to recalls or other product defect issues usually isn’t one of them. As a result, we think the recent dip in the price of GM stock could be a buying opportunity.