GE? Too Pedestrian for Me

It’s long been easy to tell favorable stories about General Electric (GE).

During the 1990s, this seemed to be everybody’s favorite stock given the cult of popularity surrounding former CEO Jack Welch. Successor Jeff Immelt has never garnered anything close to that degree of acclaim, but even he has some fans, as evidenced by the recently-released book Jeff Immelt and the New GE Way. (See also the accompanying Seeking Alpha article by author David Magee.)

Beyond leadership discussion, there’s also the company’s business portfolio. Ownership of NBC (and, of course, MSNBC and for the investment community, CNBC) gives it massive visibility, and it seems as if its collection of manufacturing businesses can often always produce at least something capable of garnering favorable, if not downright admiring, headlines. Lately, this has centered on GE as an alternate energy play. See, for example, recent coverage of GE’s high-storage batteries, GE as a green energy firm, and GE as a wind power play.

On the other hand, GE does have a major finance subsidiary. Once upon a time, this sort of thing was held to be the greatest thing since sliced bread, but lately, and understandably, investors have been acting as if they’d prefer a diet of moldy bread. But let’s face it. What happened in finance is probably a cyclical phenomenon (a massive, monstrous, cycle, but a cycle nonetheless) and there are many who believe the worst is or will soon be over.

That helps pave the way for another bullish case for GE: that it’s a play on the U.S. economy and as such, is poised for a major recovery. See, for example, the recent Seeking Alpha article Time to Reenter GE.

Looking ahead, I find it hard to imagine GE, which (like many other stocks) recently bounced off it’s epoch lows, won’t continue to rise. Let’s face it: GE is in the S&P 500 and its size gives it a healthy weighting there. So as the overall market recovers, quite a bit of money is going to find it’s way into GE even without any analytic judgment on the part of any human who actually knows what GE stands for. Being a large component of a major index has its benefits!

But saying GE is likely to rise isn’t really the point. Many other stocks are also likely to rise. If one simply wants a play on a recovering stock market, or on the U.S. economy in general, the S&P 500 SPDR ETF (SPY) will do fine.

To pick out GE specifically and say “I want this, as opposed to SPY or the countless other big-time stocks that are likely to gain” requires something more than index membership or nice stories. And “something more” is where I believe GE comes up short.

The phrase “something more” refers to a reason for believing that GE shares are likely to outperform relevant benchmarks. Different investors have different criteria here. Speaking for myself, I’m relying on a ranking system I created in Portfolio123.com called P123 Balanced. Generally speaking, it’s based on the following factors:

• EPS Growth (25%)
  • Recent EPS Growth rates
  • Recent EPS Acceleration
  • Long-term EPS Growth history
• Company Quality (30%)
  • Returns on Invested Capital
  • Earnings Quality
  • Financial Strength
• Industry Strength (20%)
  • Industry Price Trends
  • Industry Fundamentals
• Stock Valuation (25%)

Figure 1 shows the result of a Portfolio123 performance test of this ranking system from 3/31/01 through the present. It excludes OTC stocks and any others that trade below 3, and assumes 4-week rebalancing.

Figure 1

The leftmost vertical red bar represents the average annualized rate of change for the S&P 500. The dark blue bar next to it depicts the average annualized rate of change for the worst ranked stocks (those in the bottom five percent). The rightmost light blue bar represents stocks ranked in the top five percent.

While this is by no means the only way to evaluate equity performance potential, it does seem like one pretty good way to apply fundamental criteria to identify potential market winners.

Figure 2 shows how GE fares under this model now (100=best), and how it has fared under this system at three month intervals over the past year.

Figure 2

Right now, GE is squarely lodged in the middle of the pack. That is better than where it’s been recently, but hardly reason for me to prefer it to SPY or any one of many other stocks.

Moreover, GE’s middling stature is hardly new. Figures 3 and 4 show how GE fared in recent years.

Figure 3

Figure 4

Looking at Figures 2-4, two things in particular stand out.

The first is the greater number of reasonable component scores we see in 2001 and 2002. Those are likely remnants of the glory years, the 1990s.

Most noteworthy, however, are the dreadfully low scores we see, across the board, for financial strength. That may strike some as odd since GE is not generally seen as a balance-sheet-basket-case.

Much of this has to do with the fact that each company’s financial strength items are evaluated relative only to others in its own industry. This is done to prevent strong companies in normally-debt-heavy industries from being unfairly penalized. But in GE’s case, it may be doing just that. GE carries a lot of debt because it’s in the financing business, so its ratios look pretty stark relative to other conglomerates, most of whom don’t have such activities.

But I’m not inclined to let GE off the hook for this, nor would I change my mind even if finance was a more popular place to be than has been the case lately. Even under the best of conditions, GE, as presently and recently constituted, is a complex company. That, in and of itself, garners a market penalty. Almost since conglomerates were invented, they have usually been penalized with lower P/Es than their fundamentals might otherwise warrant simply because of conglomerate status. (That’s why so many have restructured and broken up over the years.)

GE chose its corporate structure. So it has to live with the inevitable investor discomfort over a muddy balance sheet that co-mingles two completely different categories of businesses.

Should I simply work harder to understand GE’s numbers? When I covered companies as an analyst, I was paid to roll up my sleeves and dig in, and I did it. That was then. Now, as an investor, my role is different. A company like GE has to compete for capital, which I, along with countless others, supply. As such, GE is little different from, say, a restaurant that has to compete for diners. It can no more suggest I should change my preferences than could a restaurant tell diners who don’t like the food to change their tastes.

This isn’t to say GE could never appeal to me. Unless it dramatically restructures, the financial rating is likely to stay very low. But that could be overcome if the company is sufficiently outstanding in other respects, which may have once been the case. Clearly, though, that isn’t the situation now, nor has that been the case for most of this decade.

Putting it all together:

• I’m not interested in books about Jeff Immelt. (There’s no bias here: I didn’t buy any of the Jack Welch books either.) When it comes to GE, I’d rather see numbers that are more than pedestrian at best.

• I am interested in alternative and green energy but that’s not enough to get me into GE, absent numbers that are more than pedestrian at best.

• Big-name TV networks are cool, but not enough to get me into GE, absent numbers that are more than pedestrian at best.

• Finance may recover, but there are a lot of other financial companies from which I could choose, so absent numbers that are more than pedestrian at best, I see no reason to use GE to play finance.

• Other GE businesses can generally sound good on paper, but absent numbers that are more than pedestrian at best, I don’t care.

• Plays on recoveries in the market and the economy catch my fancy, but SPY and lots of other stocks can supply that without forcing me to decipher a complex balance sheet and cope with other numbers that are pedestrian at best.

Disclosure: No positions

Comments

[aarc:]

Good analysis for safe investment.

SPY is the way to go for very long-term investment. Buy it and leave it then earn some dividends every year. I will be buying SPY in the next run down for 10, 20 or even perhaps 30 years hold. And some QQQQ's for their sheer potential to appreciate considerably without having to spend so much time trying to analyze the individual stocks. China's ETF too and some of India's. Oil ETF on the next run down.

But for those who want to take some risks and are nimble enough to play short to medium term. GE is definitely one of them.

GE made almost 154% price appreciation during this last "bear rally" of less than 3 months. Something that conservative investors cannot possibly make in 3 years or perhaps even 10 years unless they get lucky rather than being smart.

I expect GE to be able to go back to $42.15 or more in less than 5 years after the bottom has been set. Whether the last $5.73 remains to be the final bottom for the current 20 months old sell-off or GE goes to my price target of $3.60 is not of outmost importance. Assuming $5.73 holds, that would be a price appreciation of more than 600% in less than 5 years.

And GE has 11.30% dividend and yield at current prices as opposed to SPY's 3% yield. Not bad at all but requires a lot of steely nimble hands to maximize potential profits.

Rewards commensurate to risk. I am willing to take the risk since I know how to mitigate risk with technical analysis, so I bought GE on the way down and will buy more in the next run down. Already sold some on the way up.

What is important is that GE has a better chance of survival than many other small to medium size companies if the economy goes from worse to worst. Their economy of scale will attract droves of invetors into this company once the global gloom lifted and a new era of global economic revival follows the same path of the last century. Sounds like evangelical? Stop following and investing into markets if you don't think so.

If you can play very nimble; you can do a trading and investring strategy in this highly volatile environment since stocks specially the small to medium size companies that had been hammered so badly by the panic selling can easily make 200% to 2,000% price appreciation in a few weeks or months of relief rallies. Buy on the dips and sell at more than 200% rally half of the positions and hold the other half for at least 3 years.

Risk-free and Zero capital once done correctly. Done incorrectly and suffer the consequences so don't bet you nest egg on this strategy.

I've been doing this since July 2008. There were some early failures but the cummulative successes more than offset the losses from the few failures. Takes time, lots of work, and massive reserves of patience for the job to get done right.

This could be a "once in a lifetime" opportunity and is now starting to wind down as we approach the final stages of this 20 months saga. So most probably no "second take" in the decades ahead similar if not equal to this saga.

May 20 06:57 AM

[Mister Jimmy:]

aarc, I enjoyed your take on GE, but need to point out that its "11.30% dividend and yield at current prices" is no longer valid. The annual dividend was just reduced by GE from $1.24/year to $0.40/year, which cuts the yield to something on the order of 3%.

May 20 08:42 AM

[berloe:]

Better dead than alive? Let's break it up!

May 20 11:12 AM

[Mister Jimmy:]

Oh, yeah, berloe, whenever the New York restructuring 'geniuses' get involved, real value is created.....for them
.

May 20 12:19 PM

[searcher:]

GE vs SPY. By definition a 'conglomerate' aspires to be the market; of course, a new and improved version of the market. A version with faster growing components with #1 or #2 market positions yielding the safety of a diversified economic footprint. A version that is esteemed and rewarded with ever greater valuation by the securities market. Unfortunately, it appears an operating company can fall in love with its 'portfolio' and is just as susceptible to investment hubris as the rest of us.

May 20 01:37 PM