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Gad: GM Recall Creates Investor Opportunity

It is hoped that more and more participants have learned one yielding characteristic of the stock market: Bad news creates opportunity. How many of you wish you could go back to 2009 and reinvest all over again? In the past five years, the stock market has tripled; it's unlikely we will see another five-year period like that in the next 20 years.

But put aside the stock market and take a look at General Motors (GM - Get Report). What was originally thought to be a routine recall of vehicles with faulty ignition switches has turned into headline-making news. GM apparently knew about this problem as far back as 10 years and failed to take action. So, year to date, shares are down 14% while the S&P 500 is up approximately 2.2%.  

GM shares are trading at $35, yielding 3.5% and with a forward earnings multiple of 7x. Next year, GM will probably generate anywhere from $5 billion to $7 billion in free cash against an enterprise value today of $62 billion. The company is no longer affectionately known as "Government Motors," as the U.S. Treasury has exited its entire position in the stock.

Consider that GM today has less than $8 billion in net debt while Ford Motor (F - Get Report) has about $90 billion in net debt. GM is valued at around 5x earnings before income, taxes, depreciation and amortization on enterprise value while Ford's applicable number is 12x.

At current levels, GM is perhaps one of the most undervalued large-cap stocks in the market today. I calculate the intrinsic value of the stock to be between $50 and $60 a share, meaning minimum upside of 50% from today's levels.

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Just so you can appreciate how much emotion comes into play in the stock market, compare Tesla Motors (TSLA - Get Report) with General Motors. Tesla, which generates $2 billion in revenues and lost $74 million in 2013, commands a market value of $29 billion. In 2013, GM earned $3.7 billion in profit from $155 billion in revenue, and is valued at $56 billion.

I would argue that Tesla is perhaps more overvalued than GM is undervalued. But the evidence is clear yet again: The market pays a lofty premium for optimism and over-discounts pessimism. GM shares, in my view, are over-discounted and, in the coming months and years, the return on investment is likely to be above average.

Editor's Note: This article was originally published at 12:30 p.m. EDT on Real Money on March 19.

At the time of publication, Gad was long GM Class B Warrants, although positions may change at any time.

Sham Gad is the managing partner of Gad Capital Management, a value-focused investment firm based in Athens, Ga. Gad has written extensively for The Motley Fool and was a securities analyst for UAS Asset Management, a small value investment fund in New York City, in 2007. From 2002-2005, Gad managed assets for the Gad Investment Group.

Additionally, Gad has just released a new book, The Business of Value Investing: Six Essential Elements to Buying Companies Like Warren Buffett. He earned his BBA and MBA at the University of Georgia. Gad appreciates your feedback; click here to send him an email.

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