Kathy wood is betting, big against two companies that are about to face serious financial issues. Valley stocks are notoriously profitable relative to market valuations. Kathy believes there are two value stocks that are about to become unprofitable, kathy and other arc. Employees have been internally testing a strategy that can make them substantial amounts of profit.

This strategy is dub's arc on steroids because it essentially de-risks her portfolio from overall market volatility, while elevating returns. Two of the main stocks that she has been sorting are going through serious issues behind covers these two stocks are ford and gm ford and gm valuations have been rallying over the past 12 months. This is because investors have been betting on ford and gm's future role. In electric vehicles, ford began selling its first electric vehicle, the mustang mach e in late 2020.

The mustang machi is a fully electric suv with a price range in size, similar to the tesla model y. The specs of the vehicle are actually not too horrible in comparison to the model y, which is why value investors have been purchasing ford stock. In addition to the maki ford is about to start ramping up production for the ford f-150 lightning, a vehicle that many pickup truck fans have been waiting for. General motors has also been hyping up, its upcoming lineup of evs, most of which will start production by 2024.

Even president joe biden hopped onto the bandwagon by praising gm ceo, mary barra for leading the eevee revolution, this all sounds great, but the truth is that most of these new products are causing major financial issues. Everyone knows that electric vehicle sales are going to accelerate going forward. However, electric vehicles still make roughly 3 of total vehicle sales. That percentage is even smaller for gm, as only one percent of gm's vehicle sales are.

Electric ford is in a similar situation, with only 1.44 of their vehicle sales being electric. The fact that ford and gm stock are rallying behind this is quite ridiculous. The two automakers are growing their ev sales, but 99 of the revenue is going to disappear. To make matters even worse, ford and gm cannot afford to pour billions of dollars in the eevs when their balance sheets are suffering.

Ford has 110 billion dollars of long-term debt, while gm has 74 billion dollars of long-term debt. When excluding capital lease obligations, gm recently increased its ev spending plan by 30 to 35 billion dollars. A move that investors were bullish on ford did the same too, by boosting its ev spending to 30 billion dollars, sending its shares to record highs. All of this spending is happening while ford's credit rating has been downgraded to junk, and gm's rating is almost at junk status.

Funding such a large ev spending plan is going to be difficult, while both automakers are struggling to keep their credit rating up. If and when these two automakers borrow money, it will have to be an extremely high interest rate. One of the reasons for these low credit ratings is their low gross margin. Gem has a gross margin of 14.5 percent, and ford has a gross margin of 10.

To put this into comparison, tesla has a gross margin of 23 percent, and investors constantly criticize tesla for not being profitable. If the ev transition negatively impacts ford and gm's margins, the automakers could instantly become unprofitable value. Investors typically invest in legacy automakers because of their low p to e ratio. Gem is trading at a forward.

Pde ratio of just 8 and ford is trading at a 4 pde ratio of 10.. That sounds incredibly low, but imagine what will happen to the valuations if these two automakers become unprofitable? This may happen soon, especially since 99 of ford and gm's revenue is about to disappear. Not only that, but ford and gm are spending billions on evs that will hurt margins significantly. We saw that ford's f-150 lightning that they were going to have to double production.

Given all of the demand? Well, what they don't tell you during those appearances at ces and so forth, is that electric vehicles make up maybe two to three percent of the sales and that 97 of their revenue bases are gas, powered vehicles and, and it's probably 90 percent plus of their production. Now, if there is the combination of the consumer turning off not wanting to spend as much money, certainly not on big ticket items and a preference shift, if they're going to spend they're going to spend on electric, then these oems have an issue. They have a problem and we think we're going to hear more about it in the quarterly reports and we hope analysts start asking about it. Now i look at the i look at the performance of stocks like gm and ford.

They soared on those electric vehicle announcements. Think about that that's ridiculous. It's only two percent of their sales and what, if the other, 98 or so forth, are on their way out, as the consumer preference shifts toward electric, they have problems. They have problems because their gross margins, depending on the company, are somewhere between 10 and 20 percent.

Those are very low gross margins and if you look at the bloomberg estimates for net this year, 2022 after a very weak 2021, you see growth estimates in the 10, 15 20 range, the one you the us-based ones, are at the higher end of that. Well, that may not happen and again they don't have a lot of room for error uh and we have seen them pivoting and announcing that they're pivoting ever more quickly towards electric. But the problem is almost 100 percent of their base is going to go obsolete over time. You might be confused as to why kathy with a shorting ford in gm when she can just go long on tesla.

After all, shorting a stock means that the maximum gain is 100. If the stock falls to zero, while the maximum loss is infinite. On the flip side, if you go long on a stock, the maximum loss is 100, while the maximum gain is potentially infinite. The reason why kathy wood is doing such a move is the hedger portfolio against an overall market crash.

Everyone knows that valuations for the general market are at all-time highs and that the market will correct at some point if the market were to crash kathy's fordham. Gm short would increase in value while her long positions may continue to fall. This means that her short and long positions are counteracting each other by adding short positions to her portfolio. She is decreasing short-term volatility, while not sacrificing long-term returns.

This maximizes a statistic names alpha, which is a tracker for volatility, adjusted returns, so essentially kathy is hedging herself from overall market weakness by lowering volatility. Another reason why kathy is shorting ford in gm is because of the high predictability of the results. Warren buffett once said that, during the rise of automobiles in the early 1900s, investors should not have been purchasing auto stocks. Automobiles were replacing horses as a method for transportation, but because the opportunity was so obvious, there was too much competition.

There were hundreds of automakers entering the industry, but only a few winners ultimately survived. The sheer volume of automakers made it incredibly difficult to predict, which ones would succeed. On the contrary, it was quite obvious that businesses that sold horses were going to fail. Buffett said that instead of buying auto stocks, investors should have been shorting horse.

Related businesses kathy is using the same principle in this situation. It's almost guaranteed that 99 of ford and gm's revenue is going to disappear over time. When that happens, profits in revenue are going to dissipate along with valuations. Electric makes up about 2.

Maybe three percent of these companies uh revenues. Uh they've got 97 that we think is on its way out. We don't know how long it will take, but there's going to be a lot of obsolescence there, and on top of that, there's going to be, we think - or i think, uh pretty much a bloodbath in the used car market. So uh.

You know when it comes to valuation. I know that many analysts think that the auto manufacturers are valued around 10 times, maybe 10 times this year. We would submit that they may be looking at losses and what's the valuation, then it's infinity. So, yes, we know what we're talking about with that about when it comes to valuation, and we also know what we're talking about when it comes to technology.

We talked earlier about how ford and gm are struggling financially. The two automakers may actually be facing issues. Much more serious than that ramping up production is notoriously difficult, especially for electric vehicles. At one point, elon musk had to work 22 hours per day and sleep in the factory, because there were too many production issues, while ramping up general motors is already going through.

These issues, gm's batteries, have literally been exploding. The automaker recently had to recall 141 000 of its flagship electric vehicle, the chevrolet bolt because of fire issues. This has set back gm's ev production by a substantial amount. Gm only sold 26 electric vehicles in the fourth quarter of 2021, which elon commented on by saying room to improve ford, is also facing production issues with his mustang machi.

The vehicle's windshields have been recently popping out of the car. This is ironic because darren palmer, the head of ford's eevee division once mocked tesla for the same mistake darren once commented on ford's evs by saying the doors fit properly. The plastics and other materials color match the bumpers, don't fall off. The roof doesn't come off when you wash it the door handles don't get stuck in cold weather.

Darren is likely regretting his comment, because ford is now going through those issues that he mentioned. It's becoming clear that ford and gm are about to face the same production issues as tesla once did we're talking about massive losses, quality issues and struggles to ramp up production. All of this is in competition, not just with tesla but ford and gm's own gas counterparts. The typical ford and gm customer would usually purchase gas vehicles that are sold at higher margins, but that demand is being shifted towards ford and gm's new eevee products that have negative margins.

Let me know whether you are shorting ford and gm down below. If you enjoyed this video, please hit the like button and subscribe and i'll see you in the next one.