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Summary

  • General Electric's earnings were solid, sending the stock up 1.5%.
  • GE shares have moved up significantly in the past year.
  • What does this mean for GE's fair value and price target?

When General Electric (NYSE:GE) reported earnings yesterday, the results were generally well received by investors. The stock moved up a percent and a half on heavy volume as there was a lot to like in the report. On the back of this new information we've received regarding GE's operating results, I thought now would be a good time to update my outlook for shares including their fair value and a projection for a 2015 price target.

To do this, I'll use a DCF-type model that you can read more about here. Basically, the model uses inputs such as earnings growth rates, dividends and a cost of capital in order to compute a fair value for the company's future earnings streams while allowing for some risk. The model is inherently subjective, as all models are, but let's run through my assumptions before looking at the results.

I used analyst earnings estimates from Yahoo Finance. For the dividend, I estimated 8% annual growth in the payout, as I believe that is a very achievable target for GE. I used 3% as the perpetual growth rate and for the discount rate, I used the 10-Year Treasury rate plus a market risk premium of 5% times GE's beta of 1.19. This calculation yielded a discount rate of 8.67% for this analysis.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$1.64

$1.70

$1.82

$1.98

$2.14

$2.33

x(1+Forecasted earnings growth)

3.70%

7.10%

8.50%

8.50%

8.50%

8.50%

=Forecasted earnings per share

$1.70

$1.82

$1.98

$2.14

$2.33

$2.52

Equity Book Value Forecasts

Equity book value at beginning of year

$13.14

$13.96

$14.83

$15.78

$16.82

$17.95

Earnings per share

$1.70

$1.82

$1.98

$2.14

$2.33

$2.52

-Dividends per share

$0.88

$0.95

$1.03

$1.11

$1.20

$1.29

=Equity book value at EOY

$13.14

$13.96

$14.83

$15.78

$16.82

$17.95

$19.18

Abnormal earnings

Equity book value at begin of year

$13.14

$13.96

$14.83

$15.78

$16.82

$17.95

x Equity cost of capital

8.67%

8.67%

8.67%

8.67%

8.67%

8.67%

8.67%

=Normal earnings

$1.14

$1.21

$1.29

$1.37

$1.46

$1.56

Forecasted EPS

$1.70

$1.82

$1.98

$2.14

$2.33

$2.52

-Normal earnings

$1.14

$1.21

$1.29

$1.37

$1.46

$1.56

=Abnormal earnings

$0.56

$0.61

$0.69

$0.78

$0.87

$0.97

Valuation

Future abnormal earnings

$0.56

$0.61

$0.69

$0.78

$0.87

$0.97

x discount factor(0.0867)

0.920

0.847

0.779

0.717

0.660

0.607

=Abnormal earnings disc to present

$0.52

$0.52

$0.54

$0.56

$0.57

$0.59

Abnormal earnings in year +6

$0.97

Assumed long-term growth rate

3.00%

Value of terminal year

$17.08

Estimated share price

Sum of discounted AE over horizon

$2.70

+PV of terminal year AE

$10.37

=PV of all AE

$13.07

+Current equity book value

$13.14

=Estimated current share price

$26.21

As you can see, the model computes a present fair value of $26.21. It is important to understand what this number means as it is not a price target. This number is the present value of GE based on the inputs I used in the model adjusted for the discount rate. Thus, GE is trading right at its fair value right now according to my model.

Now, that doesn't mean there is zero upside for GE, it just means that the risk/reward has been skewed further towards risk than reward as compared to previous analyses in the past twelve months. We'd expect this to be the case as GE has moved significantly higher in the past year, as evidenced by the chart below courtesy of Stock Charts.

(click to enlarge)

One thing I'd like to point out is that GE has risen on its strong uptrend by bouncing off of the 200-day moving average. You can see the price get to the 200DMA last May, September and then again this year in February through early April. This would be your downside risk until that line is violated in my view. With the 200DMA at about $25 right now I think you're safe to own GE at any price higher than that and if we are lucky enough to see GE at $25 again in the near future that is the place to buy. Once the 200DMA is violated, you may want to reconsider but right now, it looks very solid.

So what is GE worth then? My model says shares are trading at their risk-adjusted fair value but what about a price target? GE's current forward P/E of 14.6 will be our baseline for computing a price target for next year. To do this, I'll take 2016's earnings estimates and multiply it by the earnings multiple in order to compute a year-end price target for GE, respectively. Doing this yields a 2015 price target of about $29, representing modest upside of just under 9% from here.

The lesson here is that GE has come up a lot in the past year, realizing gains that value investors saw at this time in 2013. That is terrific for anyone who held during that time but at this point, further upside potential is modest, in my view. The easy money has been made in GE and right now, I believe the stock represents a nice income stock to hold due to its robust dividend and improving fundamental prospects. The only way GE has significant upside from here is if it is able to raise earnings estimates and achieve multiple expansion, which is no small task for a company the size of GE and with the plethora of analysts covering it. GE is a great company and you can do much worse than to hold its shares. I just think the big move has already been made and at this point GE is more of an income stock than a capital appreciation prospect.

Source: General Electric: Has The Easy Money Been Made?