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.
Price-to-Sales: GE stock traded at 2.2 times sales in 2007, and this fell to 0.89 times in 2008. Since then, it has trended upwards, although the ratio currently is not as high as in 2015, when it reached 2.68.
Price-to-Earnings: GE stock now trades at 33.57 times earnings, almost twice the multiple of 17.16 it traded at in 2007. In 2008 this multiple fell to 9.42, and in 2009 it was 14.38.
EV/EBIT: This ratio was 16.2 in December 2007 and fell to 12.46 in December 2008. A year later, in December 2009, it reached 18.28. In 2013, it went as high as 40. Currently, General Electric’s enterprise value is 23.24 times EBIT.
EV/EBITDA: In December 2007, GE’s enterprise value was 13.5 times EBITDA. This fell to 9.95 in December 2008, and reached 25.38 in December 2013. Currently it is 16.78, still higher than it was in December 2007.
Bottom Line on GE Stock
On other measures, such as the cyclically adjusted P/E, GE stock looks pricey as well. GE traded at 22.25 times cyclically adjusted earnings in December 2007, and now trades at a multiple of 23.89.
General Electric stock isn’t alone, however. The broader market seems a bit frothy. Many indicators, such as median-price-to-revenue, Tobin’s Q ratio and the cyclically adjusted P/E ratio, suggest this.
It could be that these indicators haven’t kept up with the times and can’t accurately capture the value of the new economy. Maybe that’s the case. But remember, the four most dangerous words in finance are: “this time is different.”
As of writing, Lucas Hahn did not hold a position in any of the aforementioned securities.