It is hard to argue that there is no place in your portfolio for a stock such as General Electric (GE). The company is enormous, profitable, and diversified across many business segments. After taking a beat-down between 2007 and 2009 with the rest of the market, the stock has more than doubled since March of 2009. The company just raised the dividend yesterday, and the other numbers indicate that the company is in a good position to appreciate substantially over the next 12-24 months. However, exactly how much is truly anyone's guess. Seeking Alpha contributor Regarded Solutions recently made the bold assertion that GE could double in the next 12-18 months. Writer David Alton Clark countered that a double was unlikely but that appreciation is probable. No matter which author turns out to be closer to correct, there are several strategies we can employ to profit over the next 12-24 months.
In order to better understand where GE currently sits, we should take a look at the fairly recent past. The price chart above shows GE's performance from June 2007 through May 2009. You can see that the stock was down 64% over that period, but actually even more if you do the math from the peak to the bottom. It is important to remember that in early 2009 this was a sub-$10 stock. A central theme in Clark's argument against GE doubling is the fact that it already has -- from $10 to $20. While I certainly agree that it is unusual for a stock to double twice even in the span of a few years, we see that this stock dropped that far in a short timeframe.
In order to reach $40 in the coming year, we will have to see a significant shift in the valuations that the market places upon this company's earnings. As you can see in this table, at current earnings, we would have to see essentially a 75% increase in the P/E ratio in order to attain a $40 price. This is possible, but not likely in a very short timeframe. However, where things get interesting is into 2013 and beyond. As the earnings begin to increase and as GE continues to clean up the balance sheet related to certain financial assets, the required increase in P/E ratio becomes significantly smaller and much more possible. In fact, by the end of 2014 a P/E of 21 would result in a stock price of $39.69 if earnings estimates prove true.
The average analyst recommendation is currently a Buy, and the mean 12-month target price is $24.71 -- very much in line with our projected 15 P/E between 2012 and 2013. For timeframe reference, the Q4 2012 earnings should be reported in January.
So let's discuss some profitable strategies based upon our anticipation of moderate price appreciation, keeping in mind that you will need to adjust the numbers for the fees charged by your brokerage firm.
Yes, it is that simple. Buy this stock and hold it. We know that it will fluctuate, but we anticipate the stock will trend upward in the longer term. If you are able to hold the stock for several years you could certainly benefit by using a DRIP to reinvest the dividends and benefit even more from future dividend increases. Purchasing 100 shares at the current price would cost $2162, and the DRIP would provide an additional $19 per quarter for reinvestment. This of course would increase slightly each quarter as the continued investments compound, or if dividend payments increase in the future. This is a recommended strategy for those who are not interested in the effort required to build and track options positions.
This is a hybrid between a long stock position and a short call position. Building this position will require you to purchase a block of the stock in a multiple of 100, and then sell a corresponding out-of-the-money call against it for each 100 shares. The duration and amount are completely up to the investor, although calls closer to the money generate a higher premium as do durations with more time value. You receive the premium up front, and if the option is later assigned you sell the stock at the higher price. The resulting profit is the difference between the price you paid and the strike price plus premium received.
For example, assume we buy 100 shares for $2162 as in the long position above. We decide to sell a March 2013 $22 call for 60 cents against the stock -- this results in receiving $60 today. If the stock remains below $22, we get to keep the stock and pocket the $60. You are also free to repeat the process at that time with a different strike price and/or duration. However, if the stock climbs to $25 we must sell it for $22. In that case our profit is $2200 - ($2162-60) = $98. This could be frustrating to someone who thinks about how they could have made $338 instead.
Clearly the risk in this strategy is in the fact that this stock is in a position to appreciate. The benefit is that you receive the premium on the front end as well as any dividends that are paid while you hold the stock. If you believe the stock will not appreciate quickly this might be appropriate.
This is an options position consisting of an equal number of long and short contracts on the same side at different strike prices. The advantage of this type of trade as opposed to a simple long call is that the spread can often be built to profit over time even if the stock declines slightly.
Using the same March 2013 options chart, we see that the calls for $20 cost $1.84 and the $21 calls can be sold for $1.09 for a net cost of $75 per contract. In this case, we are hoping that the stock remains above $21 until March, as this will result in our $75 becoming worth $100 -- or the full value of the spread between the contracts. This would represent a 33% gain in three months. As long as the stock remains above $20.75 at expiration, we at least break even on the trade. This gives us a 4% cushion for the stock to drop before we move into negative territory on the trade. At points below $20.75 we lose money with a 100% loss occurring below $20.
The advantages of this trade are that it takes substantially less money to establish, and the stock does not even have to appreciate in order to profit. The risk lies in the leveraged nature of options. If the stock drops 7.5% in the next 3 months, you lose 100% of the investment. However, if it climbs 1.75% you profit 33%.
At current prices, General Electric is a buy. The company has taken proactive steps to clean up the balance sheet and looked for ways to improve efficiency across all sectors. The stock has continued its upward climb since 2009, and the company demonstrated their commitment to continuing the turnaround by raising the dividend. The stock price is down 5% since the last time I examined it in October, but the charts show that this is caused by other environmental factors and not anything related to the company. The company is in a strong position and I anticipate continued appreciation once the fiscal cliff is resolved and the markets calm down.
There are several strategies which can be employed to profit over the next 12-24 months in this stock, and one of them is bound to be right for you. Take your time, do your homework, and good luck out there!
Disclosure: I am long GE.