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General Electric (NYSE:GE) stock has been hammered since it reported earnings last Friday. Investors have moved the stock down based upon fears that GE's revenue growth is waning and that profit will come from cost-cutting instead of increasing sales. In addition, JPMorgan downgraded shares on Monday to neutral. After the stock has moved down more than 10% from the highs, the question for investors is whether or not the drop was warranted. This article will take a look at GE's valuation and attempt to assign a value to the shares based on the new information we have.

Despite the pessimism of the analyst community, GE's situation isn't as dire as you might be led to believe. GE reported a record order backlog and GE Capital's legacy issues are winding down in an orderly manner. In addition, analysts are still expecting 10%+ growth every year for the foreseeable future for GE.

In order to value the shares, we'll use a DCF-type analysis that requires some assumptions: 1) forecasted earnings growth and book value from Yahoo! Finance 2) dividend growth of 7%, which is my estimate 3) perpetual growth rate of 4%, which is also my number and finally 4) discount rate of 10%, which is also my number. Of course, you may disagree with some or all of these numbers, but any estimate is subject to conjecture and I have simply made my best guesses for reasonable values for these inputs.

2013

2014

2015

2016

2017

2018

Earnings Forecast

Reported earnings per share

$1.67

$1.85

$2.05

$2.28

$2.54

x(1+Forecasted earnings growth)

10.50%

11.17%

11.17%

11.17%

11.17%

Forecasted earnings per share

$1.67

$1.85

$2.05

$2.28

$2.54

$2.82

Equity Book Value Forecasts

Equity book value at beginning of year

$11.92

$12.78

$13.75

$14.87

$16.16

$17.63

Earnings per share

$1.67

$1.85

$2.05

$2.28

$2.54

$2.82

-Dividends per share

$0.76

$0.81

$0.87

$0.93

$1.00

$1.07

$1.14

Equity book value at end of year

$11.92

$12.78

$13.75

$14.87

$16.16

$17.63

$19.30

x Equity cost of capital

10.00%

10.00%

10.00%

10.00%

10.00%

10.00%

Normal earnings

$1.28

$1.38

$1.49

$1.62

$1.76

$1.93

Forecasted EPS

$1.67

$1.85

$2.05

$2.28

$2.54

$2.82

-Normal earnings

$1.28

$1.38

$1.49

$1.62

$1.76

$1.93

Abnormal earnings

$0.39

$0.47

$0.56

$0.66

$0.77

$0.89

x discount factor (10%)

0.909

0.826

0.751

0.683

0.621

0.564

Abnormal earnings disc to present

$0.36

$0.39

$0.42

$0.45

$0.48

$0.50

Abnormal earnings in year +6

$0.50

Assumed long-term growth rate

4.00%

Value of terminal year

$13.02

Estimated share price

Sum of discounted AE over horizon

$2.60

+PV of terminal year AE

$7.35

PV of all AE

$9.95

+Current equity book value

$11.92

Estimated Current share price

$21.87

Given my assumptions, GE has an approximate fair value of $21.87 per share right now. Given that shares are trading about three percent lower than that amount at the time of this writing, why should you jump in now? First, it's important to understand what this fair value calculation really means. It implies that discounting GE's earnings at 10% to compensate for the time value of money and the risk that GE will not achieve those targets still nets a fair value above the current trading price. This means that even with a relatively high bar to clear with a 10% discount rate, shares are still a bit undervalued. In essence, the fair value price is the price at which the company is still a good buy today given your discount rate and the company's prospects for the future. As GE is trading below that amount, it passes that test.

Second, the $21.87 is not the forecast price six years from now. That is the net present value of the company's forecasted earnings at a 10% discount rate plus the book value. Given the company's current forward PE of 12.75, shares would be trading at roughly $36 in 2018 if the forward PE remains the same and GE achieves earnings of $2.82 per share.

Lastly, if you look at the "Dividends per share" line in my model, you'll see that I'm forecasting GE will pay $5.82 per share in cash dividends from 2013 to 2018. That implies you've got roughly 27% of the current share price headed your way in cash distributions over the next few years at a modest 7% dividend growth rate.

Putting all of this information together means GE is a great buy at current prices. Of course, the last quarter disappointed some analysts and investors and the stock has been punished for it. However, if you are taking a longer-term view of GE's business and the fact that it pays a very nice, and growing, dividend, shares appear to be cheap here. You shouldn't buy into GE expecting 100% capital gains over a short period of time, but what you can reasonably expect is modest capital gains and a very nice dividend along the way. If that's the kind of stock you want, look no further than GE.

Source: General Electric: Reasons To Buy The Weakness