- The EV/EBITDA multiple shows the stock is undervalued.
- The market is still attaching a substantial discount to the stock.
- Recent fall in the stock price is not justified and it gives long-term investors a good entry point.
General Electric's (NYSE:GE) stock is down over 4% during the last three months. The performance of the stock is even worse (down over 8%) year-to-date. The stock has been poor during the current year after a strong 2013. The performance of GE's stock has raised some questions about the gain it had during the last year - was the gain justified? Yes, in my opinion. The rise in the stock price for GE came with a strong growth in the fundamentals as well as the movement on the strategy.
The company has been trying to shift focus to its strength, the industrial segment, and it intends to hold on to the financial assets that are in line with its industrial business. In our previous article, we talked in detail about the IPO of the consumer credit segment of the company. We believe the decline in the stock price has come due to the overall weakness seen in the market over the last few days and some profit taking. In this article, we have tried to use some metrics to value the stock.
Firstly, we will take Enterprise value into consideration for the valuation of the stock. Enterprise value is the value that a prospective buyer will have to pay for the whole company. This measure values the business of the company instead of just valuing the company. I believe this measure provides a better picture than the market capitalization as it also includes the debt of the company. If a buyer were to take over a company; he/she will have to assume the debt of the company as well and the buyer will get the cash and other liquid assets of the company, which can be used after the takeover. In order to calculate the enterprise value, we add debt, preferred share capital, and the minority interest to the market capitalization of the company, and deduct cash and cash equivalents - the resulting value is the enterprise value of a company.
The enterprise value of GE is $428 billion as opposed to its market capitalization of $255 billion. Based on this enterprise value and GE's total outstanding common shares of 10 billion, the Enterprise value per share becomes $42. However, Enterprise value alone is not completely meaningful as it takes into account all the long-term debt, minority interest and preferred capital. As a result, enterprise value will always be higher than the market capitalization. It is better to compare the EV with earnings before interest, taxes, depreciation and amortization (EBITDA). The EV/EBITDA multiple of the company stands at 11.9x at the moment - a comparison with 3M (NYSE:MMM), Honeywell (NYSE:HON) and United Technologies (NYSE:UTX) is given in the table below.
GE has an EV/EBITDA multiple higher than United Technologies and Honeywell, which means the stock is trading at a slight premium compared to these two companies. However, GE is trading at a discount compared to 3M. An important thing to consider in case of GE is that the majority of the debt comes from GE Capital, and that debt is used to earn interest. On the other hand, most of its peers use the debt to finance operations or assets. In fact, the debt for GE is working as an asset and it adds to the earnings of the company substantially. If we adjust for the debt of GE Capital, we get an EV/EBITDA multiple of close to 8x, which makes the stock look extremely undervalued. However, even if we do not adjust for the debt for GE Capital, we have an attractive EV/EBITDA multiple. GE's peers are trading at almost the same EV/EBITDA multiples with smaller operations and lower debt levels. GE's EBITDA dwarfs its peers' EBITDA - clearly showing that the market is still attaching a substantial discount to the stock.
As we have said in the past, the company is on the right path and the rise in the stock price during the last year was justified. At the moment, the company is executing its strategy well and the dependence on GE Capital is being reduced. Furthermore, the discussion of the enterprise value and EBITDA has shown that the stock is currently close to the competitors and there is still a considerable room for GE to grow. We believe the fall in the stock price have given investors an excellent opportunity to pick up some shares on a discount. In the long-term, we believe the stock price trajectory will be upwards.