GE? Too Pedestrian for Me

May.20.09 | About: General Electric (GE)

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 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

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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

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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

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Figure 4

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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