Warren Buffett said that it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price. General Electric Company (NYSE:GE) might be a wonderful company, but I find it a bit difficult to justify buying more GE stock at current prices.
It’s not always a good time to buy the stock of a good, even wonderful company. There are times of irrational exuberance, when the market is priced to perfection. In the years that follow such an episode, total returns to shareholders may be negative, even for those who bought the stocks of the best-performing companies.
The market often gets ahead of itself and sets expectations impossibly high. Even great companies like General Electric can fall off the expectations treadmill. In such periods, investors should steer clear and resist the temptation to add to their positions.
On September 1, 2000, back when Bill Clinton was still president and Jack Welch was CEO of General Electric, GE stock closed at $58.12. Over 16 years later, as of Mar. 13, General Electric stock closed at $29.86 and there haven’t been any splits since May 2000. GE stock is down 50% since September 1, 2000.
Contrast this experience with that of an investor who had bought General Electric stock on January 2, 1981, the year Jack Welch became CEO. GE stock closed at $1.29 that day, and the stock soared 4,497% in 19 years.
GE stock isn’t the only example of this. Home Depot Inc (NYSE:HD) performed well in the years following 1999, but HD stock didn’t trade at 1999 prices again until 2013. This was because 1999 was the peak of a market cycle. Expectations were simply too high, and Home Depot was bound to disappoint.
General Electric Stock’s Valuation
It’s unfortunate that investors who had bought GE stock in September 2000 would have lost so much money. All we can do, however, is try our best to avoid repeating the same mistakes.
But how do we look at the valuation of a company?
When considering a company, it’s best to look at multiple valuation ratios, since no measure can tell us everything. If a company is operating at a loss, the price-to-earnings ratio of a company won’t tell us much, so we might look at the price-to-sales ratio.
But if all the valuation ratios seem to be pointing in the same direction, this could be cause for concern.
And indeed, this is the case with General Electric stock. On five measures of valuation, including P/E, price-to-book, P/S, EV/EBIT and EV/EBITDA, GE either meets or exceeds the ratios the stock traded at when it peaked in 2007.
Price-to-Book: GE stock traded at 3.2 times book value in December 2007. This multiple plunged to 1.54 in December 2008 and bottomed out at 1.38 in December 2009. Now GE stock trades at 3.49 times book value, higher than it traded in 2007.