It was really fun for me to cover General Electric (GE) stock from the time I started finance writing in 2011 through 2014. Why? Because the price of the stock was in the mid teens, high teens, and low twenties. It was very easy to cover a business that was reporting high single digit earnings growth coming out of the recession and was in the process of ramping up its dividend that got reduced to $0.20 during the 2008-2009 financial crisis. The recovery was happening right in front of investor’s eyes but a lot of people stayed away because GE’s first dividend cut since The Great Depression was the predominant factor on most people’s minds.
But as the earnings and dividends have climbed, and the 2009 cut has become a more distant memory, investors have been more willing to appraise General Electric as it is rather than as it was. This is especially true in light of the planned and partially executed GE Capital divestitures that provided over $3 billion in annual profits to the bottom line.
I am largely agnostic on the GE Capital divestitures, as those assets are incredibly attractive and earned in aggregate a 12% return on capital. It’s just that some of them–like low-quality rental housing units in Australia or in-store consumer credit cards in the United States–suffer very high default rates during recessions and therefore to be substantially capitalized in order to prove lucrative over the full course of the business cycle.
On other hand, it is also true that General Electric was wise to wait until 2015 to start auctioning off substantial financial assets rather than panic-selling them during the lows of 2009 and the beginning of the recovery in 2010. Also, GE’s long-term P/E ratio as a pure industrial will probably pivot towards the 18-20x earnings range rather than the 15-17x earnings range because the business as a whole is much easier to analyze and the potential for a total shareholder wipeout is now virtually eliminated.
The price has reflected this. GE has a five year total return of 14.5% per year and the obviousness of General Electric as an investment isn’t quite as clear with the stock at $30 per share.
These are the data points I consider important for my current analysis:
#1. GE Industrial has a long-term earnings growth rate of 8%. Of course, GE is also a $280 mega-cap company. I take a point or two off my expectations because it is very hard to maintain high single digit earnings growth once you reach that size, and I expect 6% to 7% earnings growth over the long haul.
#2. The buyback from the sale of GE Capital is actually reducing the share count and giving remaining owners a larger share of the pie. Like with Bank of America, I’ve always been skeptical of when GE management plans to return cash through shareholders as buybacks because it never actually reduces the share count–the actual repurchased amount comes in far lower than the authority allowance, and executive compensation ends up getting mopped up. Basically, buybacks act as an anti-dilutive device rather than as a “give shareholders a bigger slice of the pie” device.
In 2003, GE had 10.0 billion shares. In 2014, GE had 10.0 billion shares. Think about all of the tens of billions of dollars in buybacks that got announced during that time. There were a few acquisitions that were able to get picked up without the share count increasing, which was nice for shareholders, but approximately 72% of buyback dollars went towards something other than protecting the share count during acquisitions.
But, that’s starting to change. GE now only has 9.3 billion shares outstanding instead of 10.0 billion, which was part of GE management’s promise for selling the financial assets. Before selling GE Capital, General Electric made $16.7 billion in profits per year and had 10.0 billion shares outstanding. Now, it makes $14 billion per year on 9.3 billion shares. That takes the profits earned by each share down from $1.65 to $1.51 but the buybacks are still being executed.
So it would not be fair to say yet that the sale of the financial assets has created any value; at best, it will be a wash wherein General Electric shareholders have a larger slice of $14 billion in industrial profits compared to a 7% smaller slice in a financial industrial making $16.7 billion in annual profits. The purpose is that the standalone industrial will merit a higher P/E ratio than a conglomerate while also improving the worst case downside for long-term shareholders.
#3. When all buybacks are completed, and the energy markets improve, GE stands to earn around $2.75 per share in profits five years from now. The current $1.50 per share figure is impacted by a significant amount of one-time costs and charges associated with unloading the financial assets, and the buybacks are expected to bring the share count down to under 9 billion. If that happens, and GE trades at a P/E ratio of 18x earnings, then the price of GE stock ought to hit $50 per share within five years.
#4. The dividend may be stalled in the near term, but ought to have 6-8% growth when measured from now through 2020-2021. Even though many of GE’s current charges are non-recurring, it still requires real cash to pay bankers to negotiate and transfer the financial portfolios to Blackstone, Wells Fargo, and so on. It has to do that, plus pay out $9 billion to shareholders as dividends. My expectation is that GE will be slow to raise its dividend substantially until after the asset sales are substantially completed, but will then offer shareholders a higher dividend growth rate thereafter.
For my own calculations, that suggests that GE still has a very good chance of compounding at a rate north of 10% over the next five years. To get from $30 to $50, you’d need the price of the stock to rise by 10.7% per year. You also get a 3% dividend, which acts as a very important margin of safety in the event that any of my projections prove too optimistic (namely, if earnings five years from now are less than $2.75 or the P/E ratio at that time is less than 18).
In short, even though GE is not as attractive as it once was, it’s still a pretty good deal. The shareholders of the last five years got 14.5% annual returns. I expect the next five years to fall within the 9-13% range, which is still pretty good and makes a General Electric investment today preferable to an S&P 500 Index Fund whose component parts are valued at 24x earnings, offer a 2% dividend yield, and carry a projected 6.5% earnings per share growth rate.
I’d still rather load up on a stock like Nike due to its superior growth characteristics, so I am not arguing that General Electric is the best stock to purchase today. However, I am arguing that General Electric is in the top quintile of stocks that will offer the most attractive risk-adjusted returns over the medium term, and carries much better potential than a plain vanilla index fund right now. For people that have been patient with their ownership position in GE, the reward will be the continuation of a double-digit compounding rate.