A single word sent Ford's stock into a tailspin

Ford car dealership salesmanScott Olson / Getty ImagesHow much can I take off?

It’s a word that strikes fear in the heart of investors in US car companies: incentives.

As soon as Ford reported second-quarter earnings Thursday, which missed expectations due in part to increased incentive spending in the robust and hugely profitable US market, investors headed for the exits, hammering down Ford by 10%.

GM dipped 4% and Fiat Chrysler Automobiles dived 8%.

The automakers’ share prices have gone nowhere for the past few years, even as US sales have boomed and the Big Three have turned in profitable quarter after profitable quarter, usually beating expectations.

It’s worth noting that Ford notched its most profitable first half in North America in company history. GM blew away earnings expectations for Q2 when it reported last week.

But still no love from Wall Street.

In Ford’s case, its corporate culture is partly to blame for the stock slide. Former CEO Alan Mulally installed an attitude of radical transparency: if there’s bad news, don’t suppress it. Instead, face up to the problem and solve it as a team.

Mulally’s successor, Mark Fields, is doing just that, hence CFO Bob Shank’s willingness to highlight rising incentive spending when earnings were announced.

I’m pretty sure that Fields and Shanks knew they were going to get clobbered. But they decided to point to their biggest current business challenge.

The dynamics of the US market are getting more sluggish. New car and truck sales ales are still good — on track to come in over 17 million for the year, a bit lower than last year, but millions above a so-called “replacement rate” market — but the automakers are beginning to smell a downturn, so incentive spending has been creeping up, according to Shanks.

Shanks also said on a call with analysts that you could see this coming: US auto sales growth has been outpacing GDP growth for a while.

Alarm Bells

This sets off alarm bells because it’s been about a decade since the last “normal” cyclical downturn, which took place before the devastation of the financial crisis, when the US auto industry was nearly destroyed.

In the mid-2000s, incentive spending got out of hand as automakers fought for market share in the US. The reason is simple: when sales aren’t growing, the one way to keep cash coming in the door is to hold share. If you have 15% of a 17-million annual market, you need to have 15% of a 15-million market.

The problem is that the increased incentive spending that comes with trying to hold or steal share leads to dive to the bottom as carmakers compete away their profits.

Since share prices of Ford, GM, and FCA haven’t really done much as US sales have boomed, the uttering of the “I” word signalled investors that the downturn is soon to be upon us and the profitability will head south, at which point car companies may start to spend cash and take on debt to maintain dividends or buy back shares.

Is Wall Street over-reacting? Of course. Ford isn’t going to shift into the red any times soon, not with gas prices low and Americans buying lots of trucks and SUVs.

Thursday’s sell-off just shows that investors wanted an excuse to get out of the sector. And Ford presented them with all the justification they needed.

NOW WATCH: Ford CEO responds to Trump’s criticism of the company

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.