In 2018, the Dow Jones Industrial Index unceremoniously dumped General Electric (NYSE:GE) stock from its list. The firm was the last of the original 1896 Dow members, and its exclusion seemed to signal an end to the once-mighty industrial company. But on Tuesday, CEO Larry Culp had a surprise message for everyone: GE is back.
Since taking the top job in late 2018, Culp has streamlined General Electric’s business – selling everything from its biotech division to lightbulbs. This week, GE Capital’s air leasing sale to AerCap (NYSE:AER) marked his most remarkable achievement yet in disposing of some of GE’s most toxic assets.
But there was another announcement that Wall Street largely ignored: a proposed 8-for-1 reverse split that would turn GE’s $12 share price into $96. Professional analysts had good reason to shrug – efficient markets say that dividing a capital base into 8.8 billion shares versus 1.1 billion should make no difference.
Except it does.
As the world looks to a post-pandemic world, don’t be surprised if GE takes off in 2021. Investors have already started rotating into value stocks. And GE’s recognition of its place in the world gives both growth and value investors a reason to jump in.
What the 8-for-1 Reverse Stock Split Means for GE
CEO Larry Culp couldn’t have picked a better time to propose a reverse stock split. Though these moves are usually to prevent low-valued companies from falling below $1-per-share and getting de-listed, GE’s move is a recognition that the worst is now behind it.
That matters. Most retail investors view a company’s absolute share value as a quality measure; the higher, the better. Some companies have taken it to extremes; Berkshire Hathaway (NYSE:BRK.A) stock is worth almost $400,000 apiece (mortal investors can also buy lower-priced B-shares for $265). But in general, most companies target between $80 to $800 for a combination of prestige and reasonable affordability.
General Electric’s low share price, meanwhile, is a relic of its once-mighty empire. The firm last split its shares in 2000, dividing its burgeoning stock in a 3-for-1 split. Since then, the company has shrunk to a shadow of its former self. Revenue has fallen 56% since its 2009 peak to just $80 billion. Today, the firm only has three remaining businesses: aviation, medical imaging and power generation.
A reverse split is a strong statement that GE won’t shrink further, nor will it succumb to the loose deal-making that sank the ship in the first place.
Re-inclusion into the Dow Jones Index
The second reason for a reverse share split is technical. The Dow Jones Industrial Index, America’s oldest stock benchmark, weighs stocks by price and not by market capitalization. In other words, 3M (NYSE:MMM) at $200 will have four times the weight as Coca-Cola (NYSE:KO) at $50, even though the former is a smaller company by equity value. It’s the reason why the index doesn’t consider high-priced companies like Berkshire Hathaway – its $400,000 share price would overwhelm all other companies in the index. Meanwhile, low-priced companies get booted for the equal, opposite reason.
General Electric’s reverse split puts the company back in contention for a DJIA spot. It’s already larger than several constituents by market cap, and further business improvements would put GE stock on par with Honeywell (NYSE:HON) and Caterpillar (NYSE:CAT).
Much still needs to happen; the firm will have to redouble efforts in marketing its wind power. GE already has a commanding technological lead, but it’s fallen short in getting governments to sign onto mega-projects. And its dominant jet engine business could take years to recover fully. Still, with countries reopening, GE could be on track to break a stock-adjusted $100 later this year.
GE Stock: Rotation to Value
GE stock is also riding a renaissance of value investing.
The 2010s was a tremendous decade for growth investors. As tech giants leapfrogged older firms, growth funds outperformed value ones by a 2 to 1 margin. Cheap stocks like General Electric, however, got left behind. $1,000 invested in Facebook would have turned into over $10,000; the same amount in GE would have shrunk to $850.
That started to change in mid-February when investors began to rotate back into value. In two weeks, value companies leaped 10% as growth stocks stalled. GE stock also reaped the windfall, rising to a $14 peak before giving up some gains.
Investors can point to increasing interest rates as a key culprit. The recent bond market wobbles have pushed long-term bond yields up, making companies with near-term profits (i.e., value companies) more attractive than those with earnings down the road. A reversal on high valuation ratios may have also played a role. In addition, an updated timeline on vaccine rollouts, since many value stocks are cyclical businesses affected by pandemic closures.
No matter the reason, investors have suddenly started worrying about paying through the nose for top stocks. Zoom Video (NASDAQ:ZM), one of tech’s most expensive companies, peaked at a 125x price-to-sales ratio in November before falling 40%. Though few investors expect growth stocks to come crashing down, many of Wall Street’s best buys are now in companies most primed to the economy reopening.
What Could go Wrong with GE Stock?
GE’s stock fell 12% on Thursday after the sugar rush of the AerCap deal started wearing off. And for a good reason. A 5-for-1 reverse split might have looked far better than its massive 8-for-1 deal. (The latter signals that GE has all but given up on growth). The firm has also lagged in pushing wind power to replace its declining coal and gas turbine business. The AerCap deal brings in cash, but not much else.
To succeed, Culp will need far more than smart asset sales – he needs a plan on growing the businesses he has left.
GE has survived many times before. And though most investors should concentrate on finding growth companies to boost their portfolio, General Electric provides a priceless hedge in a world that’s getting pricier by the day.
On the date of publication, Tom Yeung did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tom Yeung, CFA, is a registered investment advisor on a mission to bring simplicity to the world of investing.
