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Why it may be time to kick the tires on car stocks

Car stocks have been stuck in a ditch, even as U.S. auto sales rise and cyclical sectors like airlines and homebuilders have outperformed. But after two stagnant years for the shares, some investors say it's finally time to think about buying GM and Ford.

The first thing most Ford and GM bulls point to is the rock-bottom valuations. Ford is trading at a forward price-to-earnings ratio of 8, while GM is even cheaper at 6.5. That makes GM the fourth-least-expensive stock in the S&P 500, in terms of the earnings that analysts expect the company to report over the next year.

But cheap valuations don't come cheap.

Concerns around the car stocks are copious, with trouble in China serving as the biggest dark cloud over the sector.

In July, GM reported that retail vehicle sales slid in every region besides North America in the second quarter versus the year-ago period. By far the biggest worry is China, where GM is the market leader, and from which GM derives more than a third of its net income, according to Barclays. With that massive economy already weakening, concerns about a rapid Chinese deceleration weigh heavily on the stock.

"Investors are very fearful, and very, very negative on the Chinese auto market," commented Charles DyReyes, senior research analyst for large-cap strategies at Brandywine Global, where GM is a top holding in multiple portfolios. "We definitely think there's something to worry about, but it's not like the earnings power of this company will drop to zero. Bears were calling for an implosion earlier this year, and that still hasn't happened."

In fact, the company still managed to earn a pretax profit in China in the second quarter despite the weakness.

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"It seems like the market is predisposed to always be too pessimistic on GM," DyReyes continued in a phone interview. "But at seven times earnings, the market is discounting a hell of a lot of negatives in the stock. If some of those things don't happen or simply aren't as bad as the market fears, we think we can make money in GM."

DyReyes also has a positive view of Ford, though he prefers GM because of its lower earnings multiple.

Chevrolet trucks are displayed at Novato Chevrolet in Novato, California.
Getty Images
Chevrolet trucks are displayed at Novato Chevrolet in Novato, California.

Erin Gibbs, equity chief investment officer at S&P Capital IQ, holds similar views.

For both GM and Ford, "overall we're still looking at better margins, good cost-cutting, great U.S. sales, and as long as growth doesn't slow too much, we're still looking at good earnings for the next two years," said Gibbs, who holds GM in model portfolios she maintains.

Analysts, too, tend to be bullish, with the average price target on GM $40.53 and on Ford $17.65, according to FactSet. That implies a 31 percent and 18 percent rally for the respective car names.

But, the longer-term problem may be a secular one for the major U.S. automakers. As Ford and GM have slid 10 percent each in the past two years, Tesla Motors has risen 70 percent, due to an expectation on the part of some investors that electronic Tesla cars are set to take over the world.

Read MoreTesla loses HOW MUCH on every car sold?!

And even though U.S. auto sales rose to a decade-high, seasonally adjusted annualized rate of 17.8 million in May, Boris Schlossberg of BK Asset Management warns that a "cultural shift" may be underway, by which that young people "aren't nearly as excited about buying cars, period."

"They're probably very good bargains from a valuation point of view, but I wonder if long term they're facing all sorts of secular headwinds, including the possibility that no one is going to need to own a car in 10 years from now," Schlossberg said in Thursday's "Trading Nation" segment. "Maybe the market is starting to discount some of those bigger concerns."

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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Brian Sullivan

Brian Sullivan is co-anchor of CNBC's "Power Lunch" (M-F,1PM-3PM ET), one of the network's longest running programs, as well as the host of the daily investing program "Trading Nation." He is also a frequent guest on MSNBC's "Morning Joe" and other NBC properties.

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