Should I Buy GE Stock? 3 Pros, 3 Cons

by Dan Burrows | May 17, 2012 7:45 am

Shares in General Electric (NYSE:GE[1]) jumped 3.3% Wednesday in a down market after the Dow component said its GE Capital division would resume paying a dividend to its corporate parent[2] for the first time since 2009.

It’s a bullish sign that GE Capital, the company’s finance arm, has put the financial crisis behind it and is not only healthy, but apparently strong. After all, it actually has cash to spare. GE Capital will pay a special dividend of $4.5 billion this year and fork over a $475 million quarterly payout in the current quarter.

GE Capital, which offers loans, leases and financing, was a hot profit engine back in the day, but it quickly turned into a drag when the economy slowed and the financial system nearly collapsed. Now that the business is kicking cash back up to the parent, GE will have more resources to put toward its own dividend (currently yielding a handsome 3.6%), share repurchases and acquisitions.

Should you buy GE after this latest news? To decide, let’s look at the pros and cons:

Pros

Closure: The resumption of dividend payments from GE Capital to GE marks a milestone — and maybe a definitive end — to the company’s woes stemming from the financial crisis.

Cash: Capital-intensive companies like GE can never have enough cash, so getting the finance division’s dividend spigot turned on again is welcome news, indeed. GE doesn’t just need cash for its generous dividend and $12 billion share-repurchase program — it’s been doing big deals, too. On Tuesday, GE said it agreed to buy Industrea, an Australian manufacturer of mining equipment, for nearly $470 million. And in 2011 alone, GE plowed $11 billion into acquisitions in the energy industry.

Valuation: Shares look cheap on a forward earnings basis. The stock trades at a forward price-to-earnings ratio (P/E) of 10.8, which is 23% below its own five-year average, according to data from Thomson Reuters Stock Reports. Analysts’ average price target stands at $22.57. Add in the dividend, and the stock has an implied upside of 22% in the next 12 months or so.

Cons

Europe: The eurozone debt crisis rages on. Spain, the U.K., Ireland, the Netherlands, Portugal, Belgium and Greece, among others, are all in recession. Meanwhile, GDP in the eurozone is flat. GE derives about a fifth of its revenue from Europe, and the slump in the region has been taking its toll on top-line results.

Concentration: Finance and energy account for nearly 70% of revenue, and although both are improving, that may leave GE vulnerable to the twin shocks of financial-system weakness and slowing global growth. At a time when Greece is rattling the European banking system and China is struggling to boost its economy[3], being so dependent of those two highly cyclical sectors is a concern.

Pensions: The low interest rate environment has significantly driven up the liabilities associated with GE’s pension plans, note analysts at Trefis. To cover the liabilities, the company expects to make a contribution of $1 billion this year and $2.1 billion in 2013.

Verdict

If you want to play offense, GE looks good. It’s a pro-cyclical bet, one that’s highly attuned to domestic and global economic growth. Europe and China are very much a concern, but if you’re bullish that the markets and economy can get through the short-term challenges, GE’s fundamentals are the best they’ve been in years.

The company is poised to benefit handsomely from global growth. The valuation and dividend make the stock compelling, and shares appear to have been discounted to reflect future risks.

As of this writing, Dan Burrows doesn’t hold a position in any securities mentioned here.

Endnotes:
  1. GE: http://studio-5.financialcontent.com/investplace/quote?Symbol=GE
  2. resume paying a dividend to its corporate parent: http://investorplace.com/2012/05/ge-capital-resumes-ge-dividend-payments/
  3. China is struggling to boost its economy: http://investorplace.com/2012/05/inside-chinas-monetary-string-pulling/

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