GE's Cat Is Out of the Bag: Focusing on Smaller Caps

| About: General Electric (GE)
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Generally, the stocks I signal out for investigation on this blog share many traits. In an ongoing series I outline the qualifications of these story-stocks.

Naturally we're all looking for investments that will generate a superior return on our capital. If we're long the market, we're looking for issues that will rise at a greater rate than the market as a whole. If we're short, we search out the opposite. Let's assume that over the long term you expect the market to rise and are looking for issues that will outperform the market as measured by some benchmark like the S&P 500.

When I go stock hunting, I'm probably rather a lot like you. I look for stocks that I think can double, triple, or more over a significant period of time.

If you were to present me with a list of ticker symbols, my first order of business would be to check the market capitalization of each. A company's market cap illustrates the current value of the enterprise. For instance, a company with 100 million outstanding shares, trading at $10/share, carries a market capitalization of $1 billion.

Since I'm looking at the appreciation potential of a stock over the very long term, I prefer companies that are capitalized at less than $10 billion. There's only really one reason for this: They can go much higher. For instance, General Electric (NYSE:GE) is valued at around $340 billion. It's a behemoth. Can it double or triple in value? Sure and it probably will. Do I think it's a good investment? Probably not.

As a practical matter, General Electric, at $340 billion, can only grow so much. If the stock price appreciated 10% a year it would cross the $1 trillion mark in twelve years. The company would be about as valuable as the entire nation of Ireland. If it were to grow at 20% a year, it would reach $3 trillion over the same time period. In my opinion, it's just not likely that GE can achieve a $3 trillion market cap in twelve years.

I narrow my search to companies that I believe can appreciate 20% annually, looking for corporations valued between $250 million and $10 billion. These are, by definition, smaller, more agile, and yet to fully mature. Naturally, these smaller companies can feasibly deliver 20% annual returns without straining the imagination. In twelve years a $250 million corporation, appreciating at 20% a year will achieve a market cap of $2.2 billion. A $1 billion operation would grow to $8.9 billion.

Returning to a point from above, it's perfectly reasonable to expect that GE can appreciate in price in the future. However, it will take time for an enterprise that large to double, triple, or more. It will probably take a great deal of time because it's already so large. The cat is out of the bag so to speak.

A smaller enterprise piques my attention much more. It can conceivably grow much faster and offer greater returns over a comparably long time period. That's why the companies I profile on tend to fall within that $250 million to $10 billion size range. They still hold the possibility of making a huge move in the future. Larger, less nimble operations simply can't fuel enough growth to power the share price as high.

Therefore, while General Electric may be a fantastic company, you won't see it on the front page of this blog any time in the near future. It is a story that, for my purposes, has already unfolded. Stay tuned for the stories that will unfold in the very near term.