GE Is Now A Solid 'Buy' Candidate

Apr. 5.12 | About: General Electric (GE)

There was a time when General Electric (GE) was simply a manufacturing company that closely tracked the fortunes of US households. It was a steady, if stodgy performer that also paid a decent dividend; a widows and orphans stock that was even compared to the utility companies in its consistency and conservatism. Somewhere along the way, good-old GE morphed into a technology and financial services giant. It became a conglomerate of disparate companies, often with opposing interests. That's when things started going south.

With the technology collapse of the last decade, GE suffered a series of setbacks. But the CEO and head visionary of the time, Jack Welsh, had seen huge gains by letting GE Capital, the financial services arm of the business, carry the load. By leveraging its massive loan portfolio, the company was able to appear as successful and profitable as it always had - even while the quality of its earnings was in decline. Then, of course, came the big financial meltdown.

With the company so leveraged to real estate and small to mid-sized business loans, the hit to earnings was magnified. The already stretched balance sheet of the company now looked very extended, as the P/E multiple shot higher. The stock inevitably tanked. GE was being treated as a financial company, and was punished like the banks were. During the period of the financial meltdown, GE stock fell by nearly 75%.

So, what has changed and why do I feel this corporate behemoth has turned the corner and is worth investment consideration? Well, for one thing our economy is much more stable 4 years after the meltdown. For another, GE has refocused on manufacturing, and has made a commitment to shareholders not to allow the company to ever become so over-extended. Also, the demand for its technology products has grown, simply due to a resumption of global growth. With a much improved balance sheet, declining loan write-offs and business picking up, I believe now is the time for savvy investors to pounce.

Improving Business Prospects

GE competes globally with companies like Siemens (SI) in the manufacture of industrial components, Citigroup (C) and Bank of America (BAC) in the financial services area, and United Technologies (UTX) in making turbines and other high-tech machine parts. With its massively diverse product lineup, GE really has no single competitor, but its business units compete across dozens of segments.

Improvements in the global economy have led to a pickup in demand for many of GE's products. The cyclical nature of industrial manufacturing means that as things improve, the companies that have survived the drought stand to benefit mightily from the return of demand for goods and services. During the lean times, GE has streamlined business units, completed some strategic acquisitions and has jettisoned some of the less profitable operations.

Improving demand has meant increases of double digits in many of GE's most profitable business units. The energy segment has seen growth of 15% annually, while aircraft engine growth was up 14%. The home and business solutions segment of the company, which produces appliances, lighting and computing systems, grew at an impressive 54% pace. Finally, with the return of liquidity to the lending market, GE Capital saw a whopping 93% year-over-year growth rate.

GE recently announced it was expanding aggressively into the IT and data services arena, and will hire thousands of new workers in the coming years. Its strategy is to be the largest manufacturer of smart appliances and Internet-connected energy sources. This vision of a "smart grid" is one way GE will be able to expand with the growth of cloud computing. By training hundreds of software engineers to develop and maintain these remotely-controlled devices, GE will expand its services revenue - an extremely high-margin business.

Financially Speaking

GE has repurchased billions of dollars of its own stock in the past few years and has announced a 20% increase in its dividend payment. At a recent stock price of around $20 per share, its dividend yield is a not-to-shabby 3.4%. With more than $75 billion in cash and generating more than $33 billion in free cash flow annually, the company has definitely regained its financial footing.

In its most recent quarter, GE beat earnings estimates for the 12th time in the past 13 quarters, so analysts are obviously underestimating the company. Currently the stock is selling at less than 11.5 times forward earnings estimate, compared with an historical average of more than 14. With analysts expecting 12% growth over the next 5 years, this places a PEG ratio of just over 1 on the stock. And any expansion of the anticipated growth will make it even more attractive.

Although the stock has moved up with the market in the past six months, there is still room for more price appreciation. The company has been so undervalued and under-appreciated in recent years, that pundits remain skeptical. Gains of 35% over the past two quarters have left many wondering if they've missed the boat entirely - and have brought out those skeptical observers once again.

But with expenses declining, underperforming units being closed, non-core assets like NBC Universal being sold off, and earnings at the remaining core businesses growing at double digits, GE has plenty more upside. Even GE Capital is getting its financial footing again and returning cash to the parent company. All of these improvements are known to the public as well as to the analyst community which follows the company. As such, one would think that the stock would reflect this very bullish news more positively. But let's just take this gift and quietly profit from it, as this once-loved icon of American business returns to its former glory.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.