The Right And Wrong Reasons To Hate General Electric

| About: General Electric (GE)

I have never understood investors who blame the CEO for the stock performance of the company. As Warren Buffett said, it is up to the CEO to focus on growing the company and protecting the company's moat, and it is up to investors to determine the appropriate price to pay for the shares of the stock. That is why I do not get it when investors regularly criticize General Electric (NYSE:GE) CEO Jeffrey Immelt for the performance of the company since he took over.

Certainly, having faith (or a lack of faith) in a particular company's CEO is something that may affect your investment decisions. But from a valuation standpoint, Jeffrey Immelt did not really get a fair shake when he took the reigns from Jack Welch. He took over on September 7th, 2001, just four days before the terrorist attack. At the time, GE's stock was trading at $40.30 per share. At the time, GE's trailing twelve month earnings were $1.35. That is just shy of 30x earnings. For a megacap conglomerate, that kind of valuation is absurdly high. Large companies that trade at 30x earnings are almost guaranteed to experience significant P/E compression.

For instance, Value Line predicts that General Electric should trade at a long-term P/E ratio of 15. When that kind of P/E compression occurs, it means that the company would have to double earnings just to tread water as the P/E ratio compressed from the overvaluation of 30x to a more realistic of fair value near 15x earnings. Considering that it takes most high-quality large caps 6-8 years to double earnings, that almost ensured that it would take the first 6-8 years of Jeffrey Immelt's CEO tenure just to break even, and that is assuming that the business performs well and doubles earnings over that time frame. Given the gross overvaluation of General Electric that Jeffrey Immelt inherited, it is not appropriate to claim that the weak stock price performance alone under Immelt's tenure should serve as a rational basis to decline investment in the company. The firm was so overvalued in 2001 that such a comparison is meaningless.

Now, there are three pretty good reasons to be critical of Immelt's stewardship of the legendary American conglomerate. The earnings per share of the firm since Immelt took over have been less than stellar (the $1.41 per share in 2001 earnings is only expected to have grown to $1.70 per share this year) largely because of the steep profit decline that occurred from 2008 to 2009 (earnings fell from $1.78 to $1.03). The quarterly dividend cut from $0.31 to $0.10 was a significant betrayal to many income investors, given General Electric's storied history as a dividend growth firm and the fact that CEO Immelt said "We will not cut the dividend" repeatedly before deciding to, well, cut the dividend. And lastly, the implosion of General Electric's financing arm, GE Capital, during the financial crisis proved that this company carried an albatross around its neck that had the potential to sink the entire company.

Those are entirely fair reasons to criticize the company. But blanket statements such as "I'll never buy Microsoft (NASDAQ:MSFT) stock as long as Steve Ballmer is the CEO" or "I'll never buy Cisco (NASDAQ:CSCO) as long as John Chambers is the CEO" can be poor shorthand for meaningful analysis. Instead of just saying "I'll never buy General Electric as long as Jeffrey Immelt is the CEO", it can be better to analyze the reasons why you are dissatisfied with his stewardship of the company, and then determine whether those factors are still at risk today.

For instance, some conservative investors will not touch General Electric because of its dividend cut in 2009. The forward-thinking question, though, is to look at what caused the dividend cut in 2009 and then determine whether or not those risk factors still present themselves. As an industrial conglomerate, General Electric is an excellent, durable firm. It is when we consider the financing arm that things get less clear: while the GE Capital arm is currently back on track and paying things like $4.5 billion special dividends to the parent company, it is less clear how much better GE would fare if we were to experience a repeat of the 2008-2009 financial crisis. If you are going to criticize Immelt, do it for saddling a company with clear, predictable earnings with a substantial-sized operating business that is vulnerable to sharp turns in the credit markets.

The CEO of a company is likely an exaggerated reason to determine whether to invest in a company or not. But nevertheless, leadership can often be a component of making an investment decision. If you are considering to invest in General Electric, it is somewhat of a disservice to say "the dividend got cut in 2009" or "the stock is little more than half of what it was in 2001" as a basis for declining investment. Instead, you can cover more ground by asking yourself why the company had to cut its dividend in 2009, and then evaluate the risks and benefits posed by GE Capital to the other strong, underlying businesses of the conglomerate. Instead of discarding a company because of its history, it can be a much better habit to evaluate which mistakes have been corrected and which still linger. In General Electric's case, this should hinge on your analysis of Immelt's stewardship of GE Capital.

Disclosure: I am long GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.