1931-1934. 1966-1968. 1973-1974. 1986. 2008-2009. In each of those years, the price of General Electric stock declined by at least 15% greater than the stock market as a whole. This is despite the fact that General Electric was a superior company that outperformed the Dow Jones by three percentage points annually since 1933, 3.5 points annually since 1967, 2.25 points annually since 1973, one percentage point since 1986, and has underperformed the S&P 500 by a percentage point annually since 2009. The 1986 and 2009 valuation periods will eventually become more attractive once GE executes its strategy of selling financial service operations and receives a higher P/E ratio upon becoming a pure play industrial investment.
During every period except 2008-2009, the short-term underperformance of General Electric was due to temporary declines in the demand for industrial equipment that made General Electric’s profits fall further than that of the typical Dow Jones stock.
It is important that investors understand how General Electric stock will function without its financial assets. When General Electric first began to build GE Capital, the purpose was to smooth out profits over the long run by having fast-growing subsidiaries that do not move in tandem with industrial demands. If GE Industrial was having trouble boosting sales or raising prices on oil drilling machinery, it could turn to GE Capital which was collecting credit payments from hospitals that were paying off high-tech scanning equipment. And when GE Capital was having trouble collecting full rent from some of its commercial estate, it could turn to growing light bulb sales from the industrial division to buoy the day.
That layer of diversification will soon be gone. The consequence is that General Electric will see more volatility in its profits on annual basis. But this is what you need to know: Volatile profits are not inferior profits. Volatile profits are not unsafe profits. Volatile profits do not lead to underperformance. These statements are true for large-cap stocks in the industrial and energy sectors of the economy.
The smoothed out profits of GE when it contained both GE Capital and GE Industrial had a leverage and short-term liquidity problem. The temptation at GE Capital was to boost profits by lowering loan quality, or free up stagnant capital by reducing short-term liquidity. This happens to a lot of smart people in the financial sector that want more growth. That’s why the dividend got cut. That’s why GE imploded in 2009.
Going forward, General Electric is in the unusual position of becoming safer even as its short-term reported profits become more volatile. This volatility should be embraced considering that General Electric is repurchasing significant amounts of stock and provides an opportunity for attractive reinvestment of its currently high dividend.
Over the full course of the business cycle, the growth at GE Industrial hovers near 8%. That is incredibly impressive for a company of GE’s size, and will provide for attractive total returns when combined with the 3.5% annual dividend payment.
But in the short run, you might see $15 billion annual profits quickly turn towards $9 billion annual profits. Then, within a few years, it could be approaching $20 billion. That is going to be the nature of the asset going forward. The profit gains of GE Industrial in good and normal times are large compared to GE Industrial’s performance during the recessionary years, and that is what is going to make it an attractive investment.
But you should expect volatility. This won’t be like Colgate or Hershey where the profits neatly go up each year. You’re going to have to measure over five and ten year periods to see the full excellence of what GE can do. And there is an important advantage to this–you almost never get attractive opportunities to reinvest in Colgate or Hershey because the stocks don’t have the business models that create fear absent poor overall economic conditions. With GE, people that invest the $0.23 per share dividend will regular get discounts here and there throughout the coming decades. That adds up over a lifetime. But you should be prepared for this volatility, understand that it is not synonymous with lower quality, and take advantage of it by reinvesting so that it serves you.