By Mark Bern, CPA CFA
In a word: maybe.
It really depends on the investor’s goals, time horizon(s), and tolerance for risk. General Electric (NYSE:GE) is a huge, global industrial company that serves multiple types of customers in more than 100 countries and does so with a widely varied line of products and services. The company has a history of building a leading position (number 1 or 2 in market share) in an industry/sector through a combination of acquisitions and organic growth. When a subsidiary can no longer maintain a dominant position in its industry GE or its growth in sales or earnings no longer meet GE’s standards the subsidiary is divested through sales or other such methods to improve GE’s return on capital deployed.
GE stock has fallen on hard times over the last decade having not risen to levels that were seen prior to the recession of 2001-02. Earnings per share in 2011 were $1.41 while in 2007 EPS hit $2.20. Most recently, in 2010 EPS were $1.15. Barring a major, global-scale recession I expect GE to grow EPS by an average of about 15% per year over the next four or five years. That expectation is based upon several factors: Stronger order flow in coming years, expansion in fast growing international locations such as India and China, revenue expansion in higher-margin services, as well as the stabilization of the wind turbine business which has been a drag on margins.
Infrastructure orders have risen more than 20% year-over-year. GE’s order backlog has risen to record high levels. Overall, industrial revenues increased 12%, but the international revenues rose by 25%, with the best performances coming from the BRIC (Brazil, Russia, India and China) countries as well as Canada, Mexico and the Middle East regions.
Third quarter earnings from the transportation unit increased an astounding 94% with 169 locomotives shipped in the quarter compared with 99 in the third quarter of the previous year. The other big gainer this quarter was GE Capital with earnings rising 79% year-over-year. Out of the total EPS for the quarter of $0.31, $0.14 came from GE Capital. That, of course, is both good news and reason for concern.
I expect more turbulence in the financial sector over the next two years, at least. The fact that such a large portion of GE’s earnings are derived from one segment is, in itself, a risk factor in that it reduces the safety that usually results from diversification. The risk is further accentuated by the source being from the financial segment of the company which, in my opinion, carries significantly more risk than most other segments in the short-to-intermediate term. However, over the longer term, I expect GE will outperform other diversified industrial companies due, in part, to the earnings potential of GE Capital.
There are risks, especially until some resolution to the European sovereign debt crisis is found. I don’t know whether there will be a soft landing or hard landing for the EU, but as I watch the deliberations and evaluate the proposals I am inclined to expect a higher probability of a hard landing. That will impact equity markets globally with virtually nowhere to hide. The silver lining is that when the dust settles much of the excessive debt will likely be purged into oblivion from where it came which should create a firmer foundation from which to grow. At that time GE will be well-positioned to take full advantage of global growth for years to come.
So, how do we define the answer? Maybe?
For the investor willing to ride the roller coaster and in need of a good dividend, GE may not be such a bad investment. However, I think that a better (lower) entry point is likely to be available over the next year or so. For me, I’ll wait. But, if I’m wrong about the macroeconomic course we take, I could miss out on 20% average total annual returns over the next five years. So, once again, we must all make that decision about what fits best in our individual portfolios. My hope is that my perspective helps some folks with that decision.
Disclosure: I am long UTX.