The Story Behind The Volkswagen Scandal

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Living in the United States, where we proudly sell SUVs that can fit a dozen people and pickup trucks that could tow a trio of fully-grown elephants, it's hard to imagine an American auto manufacturer facing fallout over questions of their emissions.  After all, with YouTube videos of "rolling coal" (disabling the filter of a diesel engine to burn fuel significantly faster) gaining millions of hits, the stock of Ford might rise if their CEO announced that F-350 supercabs no longer could adhere to the standard emission rates.  Yet Germany is not the United States and, in a nation that wants to be carbon-neutral within the next decade, the announcement that Volkswagen's in-car computers had been programmed to under-report the emissions from some eleven million cars racked the third-largest automotive company on planet Earth.  With a stock price that's already down by 34%, investors need to ask when is right to jump in to either short the stock further or make a value buy.

Emissions Conditions

The United States has only slowly began to catch on to the practice of carbon trading a few years after it has become a very viable market through the rest of the industrialized world.  As governments offer tax credits for carbon offsets, companies that can demonstrate their products do better for the environment than the average can make money with both eco-minded customers and come tax day.  Volkswagen has cashed in on this policy with great success in Germany and sought to do so as well in the United States under the standards of the Clean Air Act, which limits the output of carbon dioxide from vehicles.  Though critics of the Clean Air Act charge that US policy enforces this subjectively, which is why we classify an SUV as a light truck rather than a car, Volkswagen nevertheless faces an $18 billion fine for cheating on emissions testing, which would be twice the company's total profits and almost ten percent of their total revenue from last year.  While they've already set aside about eight billion dollars in order to handle recalls, it's very likely that VW will end up the year with serious struggles in their cash flow, posing a huge loss to investors who snatched up their stock (VOW3 on the XETRA German stock exchange, trading for $112.15 a share) during peak value in April when the stock price was over twice as high as it is today.  For a value investor, however, who had no previous shares, this seems to be a good time to buy in and get ultra-low stock of a steady grower that, prior to the scandal, had increased in value ten-fold between 2008 and 2015.  Yet it's quite possible that the best value is yet to come.

Scaling Losses

How hard would an $18 billion price tag hit VW?  To say a lot would put it mildly.  The Financial Times estimates that a fine as low as $2 billion would shave four Euro (about five dollars) from the company's stock price, while a fine that hits at the high point of $18 billion would trim thirty-five Euro (about forty dollars) from each share.  They released the report just after the worst two days in the company's financial history, when prices fell by sixty dollars in less than 48 hours.  The Clean Air Act may only be the tip of the iceberg for VW, however, as the inquiries in the US have opened up official investigations by the ministries of transportation in France, Britain, Australia, and South Korea -- all nations with stricter air pollution laws than the United States.  While there's no way to know how far VW will far before it all ends, they've already done worse relative to their 52-week high than British Petroleum did in the aftermath of the 2010 Deepwater Horizon oil spill that launched approximately five million barrels of oil (at the time, worth half a billion dollars) into the Gulf of Mexico.  That means that the worst appears yet to come, but recovery should follow quickly after that.  After all, BP outperformed the market for the five years after the Deepwater Spill, while VW has done twenty times better than the Dow Jones Industrial since 2005. 

  • The Takeaway: there's no rush to hurry into buying VW stock although every investor should keep a very close eye on their prices.  Heads will surely roll as a result of the scandal (CEO Martin Winterkorn resigned and the company brought in the head of subsidiary Porsche to take over) and the fallout could take months to clear up.  Once the stock has passed beneath whatever margin you deem acceptable -- higher-risk portfolios should have no qualms buying into VW immediately, while lower-volatility portfolios should can give it four to six weeks -- investors can ride it out over the long term.
  • Volkswagen has had very few periods in their company history with extremely fast growth.  Over the past five years, only one stretch of six months has seen VW rise by more than fifteen percent despite the company enjoying just over 12% growth in the same span of time.  Though they'll likely get back on their feet relatively quickly, VW's not a pump-and-dump stock.  Value buyers should plan to give it a long time to grow to fruition before cashing it in once the scandal has become a distant memory.
  • While Honda, Ford, and Nissan are surely happy to read the news, no major competitor has seen their stock prices grow noticeably.  Indeed, shares of Toyota had their worst performance of the month the same day as the news broke.  There's no clear winner in the auto market at the moment other than those looking for bottom-barrel bargains.

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