General Electric: On the Way to Retesting Previous Lows?

| About: General Electric (GE)

For years, investors boosted what a great company General Electric (NYSE:GE) was. Even CEOs marvelled at the company's ability to consistently deliver strong earnings growth despite its massive size. Microsoft (NASDAQ:MSFT) CEO Balmer even began to study GE's financial statements looking to for a way to duplicate its creative use of numbers.

Apparently, Mr. Balmer was a bit too focused on the numbers and not the source. For if he had looked closely, he would have seen through the smoke and mirrors.

Over the past several years, as America's credit bubble swelled, the key to earnings growth for many mature companies has been to enter into the finance business because the accounting trickery allows one to hide liabilities, overvalue assets, report income that is deferred and not assured and many other things that introduce a tremendous amount of risk, as well as questionable business and accounting practices.

But now the truth has surfaced. I'd say Balmer has stopped pouring through GE's financial statements.

Those who read America's Financial Apocalypse or Cashing in on the Real Estate Bubble might recall I mentioned that GE and General Motors would take a big hit from the collapse of the real estate bubble. I knew this for a fact because I was well aware these corporations were largely commercial banks.

About a year ago, during the midst of the shakeout of the financial industry, I told my clients that GE would see $5 before it was all over. At the time, the stock was hovering around $25 per share. Less than seven months later, GE fell below $6 during the market collapse in March 2009. Since March 5th, it has staged an impressive rally, up by over 140% versus 50% for the Dow (click to enlarge).

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So is the worst over for this conglomerate?

In my opinion, not by a long shot. GE continues to be the most leveraged corporation in America, and one of the most highly leveraged corporations when you include the financials. Of course, GE is largely a financial company, but not so much as the largely insolvent Citigroup (NYSE:C).

As an attempt to deleverage, GE is looking to sell its security business unit. Most likely, the company is also shopping several other units as a way to salvage what's left. But the the question is whether it will be able to survive what promises to be a continued severe economic period lasting years.

In April 2009, the FASB eased mark-to-market accounting rules when the market has been deemed to be "unsteady" or "inactive." The rationale for this is that a market with low volume or sporatic activity is not expected to price assets accurately. As a result of this change, bank earnings and losses have been boosted.

But the change also extends to derivatives.

This is a huge deal. Overall, the change to mark-to-market accounting makes securities valuation very difficult. As a result, this can potentially lead to an artificial inflation of a company's assets and earnings, while masking inherent risk.

In short, I certainly wouldn't be looking to buy or even trade GE here because the collapse could occur next week or next year.

One thing I am certain of. If GE does not find a way to reduce its massive leverage, it will fall precipitously over the next several months and could retest the lows made just a few months ago.

No one knows for certain what GE Capital has on its books, including management. So it's going to be very difficult for management to mitigate further risk.

Perhaps its best ally in this mess might be the U.S. Government. But that does not necessarily mean GE represents a good investment opportunity here. There are many ways shareholders can get the shaft, namely by dilution.

In short, I certainly wouldn't be looking to buy or even trade GE here because the collapse could occur next week or next year.

One thing I am certain of. If GE does not find a way to reduce its massive leverage, it will fall precipitously over the next several months and could retest the lows made just a few months ago.

I am betting that GE will see the $11 mark sometime in 2010. From there, things could get really nasty. Maybe I'm being too cautious or pessimistic. We will have to wait and see.