There is perhaps no more iconic American business than General Electric (GE). The 19th-century brainchild of Thomas Edison himself, GE stock was an original component of the Dow Jones Industrial Average from its inception in 1896.
Today, GE is an international conglomerate with its hand in a diverse array of fields. In fact, critics of GE stock worry the company is too diverse, citing the fact that its many endeavors span the fields of technology, finance, medical devices, aviation, the media, appliances, and energy — to name a few.
With recent calls for GE to break itself up and spin off parts of its businesses into mini-GEs, let’s examine three pros and three cons facing GE stock today.
GE Stock Pros
Breakup Potential: Scott Davis, a Barclays analyst, called for the mighty General Electric to split itself up last week, arguing that doing so would allow investors to recognize the discrete value of each segment GE spun off. It’s a solid argument: Because of GE’s girth and diversification, GE stock is unlikely to fetch high multiples on Wall Street, even if some of its divisions — Davis suggests GE’s healthcare business specifically — could probably command lofty valuations if they broke free of their sprawling parent.
Stock Price: The forward P/E ratio is widely used by investors as a fast way to check whether any given stock is trading at reasonable levels. The metric divides today’s stock price by the next 12 months’ estimated earnings, telling investors what the P/E ratio will be one year from now if the stock price doesn’t move and earnings come in as expected. The forward P/E of GE stock, at 14.3, is lower than the 16.85 forward P/E of the S&P 500 Index itself, implying that GE stock is about 15% cheaper than the average S&P 500 stock.
Cash: You can’t ignore cold, hard cash when it stares you in the face. Especially when it’s $86 billion we’re talking about — the sum that GE boasts in cash and equivalents. This enables GE stock to pay a generous 3.5% dividend, while freeing the company up to do things like acquire competitors, buy back shares, and invest heavily in itself.
GE Stock Cons
Slumping Sales: Pros aside, not everything is peachy with GE stock. Revenue has been on a steady downtrend since the 2009 fiscal year — a year, if you’ll recall, in which the U.S. economy was more or less in shambles. GE itself was less than a year removed from relying on the government to step in and insure $139 billion of its debt in a desperate move to preserve its liquidity. In context, the fact that GE sales actually fell by more than 8% between 2009 and 2013 tells you something is amiss.
Waning Free Cash Flow: Numbers don’t lie. And the honest truth told by General Electric’s cash flow statement is an ugly one: Free cash flow, or FCF, is trending lower in a major way. It began declining in 2011, and last fiscal year the conglomerate produced a mere third of the FCF it produced in 2010. In the past two quarters, free cash flow has actually been negative.
Overdiversified, Boring: Legendary growth investor and former Fidelity fund manager Peter Lynch called the process of poorly chosen diversification “disworsification.” You might argue that GE stock has suffered precisely because of this phenomenon: It was the woes of GE Capital during the financial crisis that threatened GE’s very existence several years ago. Of course, Google (GOOG) might also be accused of disworsification in light of its seemingly endless pursuits and zany, longshot projects. But Google could never be called “boring,” a pejorative that GE stock may have rightly earned considering its 15-percentage-point underperformance this year.
Verdict
General Electric needs to shake things up to turn GE stock into anything other than a mindlessly held blue-chip. Although the company is rolling in dough and the stock is arguably cheap in comparison to the market, management would do well to break the company up in the interest of boosting shareholder value.
We’ll see if a light bulb goes off anytime soon.
At the time of publication, John Divine owned GOOG and GOOGL.
