In this article we're focusing on GE (NYSE:GE) and comparing it to Honeywell (NYSE:HON). Although GE is far bigger than Honeywell, with it having a market cap of $255 billion versus $73 billion for Honeywell, they share the same GICS sector of industrials and also sit in the same GICS sub industry of industrial conglomerates. Clearly, GE's operations are extremely diversified, ranging from airplane engines to finance products, so a perfect comparator is hard to find. However, we feel that for investors looking at how best to apportion their capital within the industrial conglomerate sub industry (and within the industry sector), a comparison between the two stocks could be useful. As ever, we welcome your suggestions on future articles and hope you enjoy the article!
In terms of profitability, we're impressed with GE. Although it's a huge, sprawling business it still is able to deliver reasonably strong profitability numbers, with return on equity being 11% last year and the company having an operating margin of 12%. This is impressive, since cost control can be tough to keep under wraps as a company expands, so we're pleased to see that GE is keeping a handle on its expenses column.
However, GE's profitability is definitely second-best when being compared to that of Honeywell. For example, it has a return on equity of 25% and an operating margin of 14%. Impressive numbers, but what really stands out to us is Honeywell's ability to achieve these levels of profitability despite only running a relatively small amount of debt on its balance sheet. Indeed, its debt to equity ratio is just 48%, while GE's is 270%, which goes to show how successful Honeywell is at delivering a high return on equity.
Clearly, when we're looking at so-called 'mega caps' such as these two companies, many investors are going to be concerned with yields. On this front, GE really delivers for its shareholders. For example, its forward dividend yield is 3.3% and we feel that there is scope for this to push northwards because the company has a dividend payout ratio of just 67%. For a company as mature as GE, we think this could be raised and that would mean a higher dividend for investors. Honeywell, meanwhile, also has significant scope to increase dividends, with its payout ratio standing at just 34%. Its yield at present, though, is some way behind that of GE at 1.9%, meaning the larger peer is likely to be more attractive to income seeking investors.
Where GE loses out to Honeywell, though, is in terms of earnings growth potential. Indeed, Honeywell is forecast to increase its bottom line by 11.2% next year, which is well ahead of the market and higher than GE, since it is expected to grow earnings by 9.6%. This is still an impressive number, although slightly behind Honeywell, especially when GE's sheer size and scale is taken into account.
When looking at the two companies' valuations, we're mindful that a stock as large and as diversified as GE deserves a slight premium to its smaller peer. That's because it should deliver a more consistent growth profile going forward and is less susceptible to downturns in one or more industries, with it having exposure elsewhere to pick up the slack.
However, we feel that the current valuations of the two companies indicate a mispricing. For example, GE's P/E (TTM) is 21, while Honeywell's is just 18.8. That means that GE trades at a premium of 11.7% to Honeywell based on this metric, while its PEG ratio of 2.14 is 32% higher than Honeywell's 1.62. In addition, an EV/EBITDA ratio of 22 versus just 11 for Honeywell appears to be too high in our view. As a result, we think that GE's shares could be overpriced relative to Honeywell's and, as such, it could underperform its sector peer going forward.
We're impressed with GE's profitability, income potential and growth prospects. However, yield aside, Honeywell offers better growth and higher levels of profitability than its larger peer. Furthermore, the current valuations of the two stocks do not appear to take this into account, with GE trading at a substantial premium to Honeywell based on various valuation metrics. Therefore, we feel that GE could underperform Honeywell going forward, as investors react to what appears to be a mispricing in the market.
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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.