Gauging GE (General Electric)

General Electric (GE) is a large and diversified manufacturing, finance, and media company.  From light bulbs to locomotives, household appliances to nuclear reactors, aircraft engines and power generation to financial services, medical imaging, as well as movie and television programming, GE operates in more than 100 countries and employs nearly 300,000 people worldwide.

GE was the monthly Online Stock Study for March 2011 that was led by Adam Ritt, the editor of Better Investing magazine and Communications Director at BI.  The online participants in the monthly stock study use consensus decisions to make their SSG judgments.  Adam’s handouts, presentations slides, and the Consensus SSG are all available to BI members.

Company Background:

 – General Electric is the nation’s largest corporation and 2010 was a very good year for GE.  It reported profits of $14.2B with $5.1B from operations in the United States.

** Astonishingly, GE paid no U.S. taxes and actually claimed a $3.2B tax benefit last year according to the New York Times.

** In the last 5 years, the Times reported, GE has accumulated $26B in U.S. profits and received a net tax benefit of $4.1B.

 – GE’s FY 2010 EPS was up 11.7% and its 4Q EPS increased 25.0% based on Morningstar data via BI.

 – But, GE’s historical growth has been dreadful:

 ** Its EPS growth rate has worsened AND been negative for 8 out of the last 9 years, from -1.6% in 2002 to -19.6% in 2009;

 ### 2010 was the first year of positive growth in a decade!

 ** Its Sales growth rate also has worsened AND been negative for the past 5 years, from -0.1% in 2006 to -4.2% in 2010.

– General Electric is organized into five segments: Energy Infrastructure, Technology Infrastructure, NBCUniversal, Capital Finance, and Home & Business Solutions.  Financial services accounted for 25% of GE’s profit in 2010.  The five segments are:

** Energy Infrastructure [25.4% of 2010 sales, down 8%] makes wind, gas & steam turbines and generators, nuclear reactors, oil and gas extraction equipment; water, waste water and desalination equipment; oil and gas drilling equipment including surface and subsurface gear; electrical distribution and control gear, lighting and power panels, circuit breakers, and commercial lighting systems.

** Technology Infrastructure [25.6% of sales, down 2%] is made up of three sub-segments following a 1/1/11 reorganization: Aviation (jet and turboprop engines); Healthcare (X-Ray machines, CT scanners, MR technologies); and Transportation (diesel-electric locomotives, large mining truck engines, transit cars).

** NBC Universal [11.4% of sales, up 9.5%], consists of the National Broadcasting Company (NBC) broadcast television and radio networks; Universal Pictures; Universal Studies Theme Parks; Cable TV Networks including: USA, Bravo, CNBC, MSNBC and others.  GE plans to sell its 80% share of NBCU in early 2011.

** GE Capital [31.8% of sales, down 5.4%] makes commercial, personal, and home equity loans; finances operating leases and fleet mangement arrangements; issues private-label credit cards, bank cards; provides fixed and floating rate mortgages.

** Home & Business Solutions [5.8% of 2010 sales, up 2.4%] makes, sells and services consumer products such as stoves, refrigerators, dishwashers,  washers, dryers, microwave ovens, room air conditioners, and residential water systems; and its Intelligent Platforms sub-segment makes plant automation equipment.

History:

– GE traces its roots back to Thomas Edison when, in 1892, he merged his Edison General Electric company with Thomson-Houston Electric to form General Electric. 

– In 1896, GE was one of the original 12 companies that made up the newly formed Dow Jones Industrial Average and still remains on the Dow after 114 years.

SSG Discussion:

– The following table compares the Consensus SSG with mine, Take Stock, and with an older SSG by Adam Ritt.

– After the table, I discuss GE’s downtrending Pre-Tax Profit Margin AND Return on Equity as well as its Financial Condition.

GENERAL                 ELECTRIC (GE)	Consensus SSG led by Adam Ritt	Armin	Take Stock	Adam Ritt
Date	3-2-11	3-4-11	3-6-11	6-25-08
Data	Mstar via BI	Same	Mstar via SC	S&P via BI
Share Price	$20.37	Same	Same	$28.48
52 week High &     Low Price	$21.65 & $13.75	Same	Not Used	$42.15 &         $27.20
Last Q of          Reported Data	Q4 ending     12-31-10	Same	Same	Q1 ending          3-31-08
Project Growth from End of	Last Q (maybe)	Last Q	Last FY	Unknown
Software Used	Online SSG	TK 6	TS Online	TK 5
Sales Estimate	05.00%	10.00%	-0.03%	7.00%
EPS Estimate	07.50%	10.00%	-6.10%	7.00%
Est High PE	17.10	17.0                (09-10 ave)	18.7	14.0                  (PEG of 2.0)
Est High EPS	$1.65	$1.85	$0.84	$3.25
Est High Price	$28.22	$31.50	$15.68      (48% < VL)	$45.50
Value Line Estimated High Price = $30-45 as of 1-21-11
Est Low PE	11.22	8.8                  (2009-10 ave)	10.6		10.0                 (PEG of 1.5)
Est Low EPS	$1.15	Same	Same		$2.33
Est Low Price	$12.90       (low PE x low EPS)	$16.30         (80% x current price	$20.37        yield supp    low price		$23.30
RV/PRV                    (no outliers)	Not Used	118.6/107.4	Not Used		66.8/62.4
RV/PRV                (outliers out)	Not Used	137.2/129.8 (2006-08 out)	Not Used		Not Used
Upside/Downside Ratio	1.06	2.7	Impossible to Compute		3.3
Total Return	9.98%	12.80%	-2.80%		13.40%
SSG Buy Under	Not Used	$18.04	$8.67		Not Used
Quality	N/A	N /A	TS = 1.1		N/A
PTPM – 5 yr ave	11.22% Trend N/A	11.2%         Trend down	Same            Trend N/A		15.7%      Trend up
ROE – 5 yr ave ending equity	14.78% Trend N/A	14.8%         Trend down	Not Used		18.1%       Trend up
ROE – 5 yr ave        begin equity	Not Used	15.0%        Trend down	Same             Trend N/A		Not Used
Debt to Equity	Not Used	269.9%       Trend down	Not Used		Not Used

Estimating EPS Growth for the Next 5 years:

– Adam gave participants five options to estimate GE’s EPS growth for the next 5 years: 5.00%, same as their Estimated Sales Growth judgment; 5.50%, historical growth 2000-2010; 7.50%, VL’s 3-5 year estimate; 14.00% Analyst’s Consensus Estimate (unspecified, but may be S&P’s next three year estimate); or 12.00%, ACE less 2.00%;

** GE’s dreadful historical record was not mentioned: negative EPS growth rate for 8 of the last 9 years, from –1.6% in 2001 to -19.6% in 2009.  In 2010, GE’s EPS growth was a surprising 11.7%.

** The Consensus pick was 7.50%, VL’s estimate [47% of the votes, presentation slide 20].

– When I did my SSG, the seven different long-term estimates I ALWAYS check averaged 11.92% with Value Line low at 7.50% and Reuters.com high at 14.58%.

** Zacks.com was 10.33%, Morningstar.com was 11.60%, CNNMoney.com was 12.70%; YahooFinance.com was 12.80%, and Zacks via BI was 13.90%.

** I decided to use 10.00%, low but not the very lowest estimate.

 ** To learn more about Estimating EPS, see: Estimating EPS [click here]  

– Take Stock estimated -6.10% growth (that’s a negative 6.10%) for the next 5 years based solely on GE’s atrocious historic performance and Take Stock’s ultra conservative design.

– In 2008, Adam estimated 7.00% EPS growth, the same as his Sales estimate at that time.

Estimating the High PE for the Next 5 Years:

– Adam gave the group four choices: 18.90, GE’s 5 year historical average; 17.10, its average during 2009 & 2010; 11.25 or a PEG of 1.5, (1.5 PE x 7.5 E); or 15.0 or a PEG of 2.0 (2.0 PE x 7.5 E).

** The Consensus pick was 17.1, GE’s average High PE during the last two years [30% of the votes, slide 23].

– I also picked GE’s average High PE during the last two years because the 5 year historical trend was noticeably down and I eliminated the first three years as outliers.

– I don’t use the PEG ratio because one number, I believe, is not appropriate for all stocks, whether that number is 1.5 or 2.0 or 3.4567 <grin>.

Final Results:

– The Consensus SSG began with a 7.50% estimated EPS for the next 5 years and a Forecast High Price of $28.22.  It got a 1.06 Upside/Downside and a 9.98% Total Return which did not satisfy the SSG Buy criteria of 3.00 U/D and 15.00% TR;

– My SSG began with a 10.00% estimated EPS and a Forecast High Price of $31.50.  I got a 2.7 U/D and a 12.80% TR which also did not satisfy the SSG Buy Criteria;

 – Take Stock began with a -6.10% estimated EPS which seems unreasonably low and nutsy compared to all the other EPS estimates.  It got a U/D that was impossible to calculate and a -2.80 % TR, all because of its weird estimated EPS.

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

– PTPM and ROE (with beginning and with ending equity) are all trending down which are typically red-flag warning signs, but are hard to interpret in our current recession/financial slump.

** The BI Stock Selection Handbook says that PTPM and ROE “should both be above the industry average and trend upward….Upward trends indicate that management not only keeps things running, but also makes improvements as a matter of course.” [page 93, 2003 edition]

– Morningstar places GE in the Diversified Industrials Industry which has 168 companies.

** GE is slightly better than its industry average in terms of PTPM (11.2% vs 10.5%) and ranks 43^rd of 168 companies.

** GE is slightly worse in terms of ROE (14.8% vs 15.5% adjusted to remove four companies with ROEs over 100%; the unadjusted industry average was 25.1%) and GE ranks 42^nd in the unadjusted industry.

** Compared to United Technologies, a direct competitor in the same industry according to Morningstar, GE’s PTPM is slightly worse (11.2% vs 11.6%) but better in terms of ROE (14.8% vs 11.6%).

** And, compared to Siemens (SI), a direct competitor that is in the Conglomerates Industry, GE is much better in terms of PTPM (11.2% vs 5.7%) as well as ROE (14.8% vs 7.7%).

Financial Condition:

– Value Line gave GE a Financial Strength rating of B++ which VL did not explain and which seems moderately low, especially for such an essential company, as A++ is its highest rating and C its lowest.

** UTX, a top competitor identified by Morningstar, got VL’s top rating of A++.

** VL also reported that GE had cash of $1.24B, total debt of $422.4B, long-term debt of $307.5B, and an interest coverage ratio of 1.7x, all as of 9/30/10;

** Compared to GE’s 1.7x, an interest coverage ratio of 1.5 is generally considered the bare minimum for any company in any industry according to Investopedia.

– Morningstar gave a short and skimpy assessment of GE’s Financial Health: that its industrial unit generated a healthy cash flow (14% of 2010 revenue) and held $19 B in cash; and that Mstar was confident GE would be able to repay or refinance its upcoming obligations.

** Note the large discrepancy between Mstar’s report of $19B cash and VL’s report of $1.24B cash.

– Morningstar SSG data from BI showed that GE had $411.3B in Total Debt and a Debt to Capital ratio of 77.5%; and a Debt to Equity ratio for 2010 of 245.6% trending down from 289.7% in 2009 and 311.5% in 2008.

– The Analyzing the Annual Report spreadsheet by Bob Adams gave GE 73 out of 100 with 11 Bearish results (good things) and 5 Bearish (not-so-goods).

** The Bullish goods included: accounts receivable, inventories, debt, and shares outstanding are all decreasing; return on free cash flow is good.

 ** The Bearish not-so-goods included: sales are decreasing; interest coverage at 1.9 is low and got a red flag warning sign; Debt to Equity at 303.3% is high and also received a red flag; ROE is inadequate and   got a yellow caution flag.

 ### You can get this free and easy-to-use spreadsheet (all it takes is to enter the ticker), and an explanation of its many features, by going to my Favorite Links page [click here].

### Bob’s spreadsheet is primarily for anaylzing manufacturing and retail companies.  GE, in addition to its manufaturing, also provides a substantial amount of financial services which complicates any analysis of its financial condition.

Final Thoughts:

– GE seems like a poor long-term investment:

** It did not satisfy the SSG Buy Criteria AND its 5 year average Pre-Tax Profit Margin and Return on Equity were both trending down which are red-flag warning signs of poor quality.

– However, GE was the #1 stock held by BI Investment clubs in terms of the number of clubs (2,748) and shares held (1,831,965) according to a recent survey reported in the April 2011 issue of BI magazine:

 ** Why, what do you think is going on: do these clubs not use the SSG or never do a follow-up assessment?  Are there any other reasons you can think of??

 

Armin