Fade This Rally in General Electric Stock Ahead of Earnings

General Electric (NYSE:GE) finally is showing some signs of life. Just a month ago, GE stock was at $6 and threatening to breach the 28-year low it hit in May.

The General Electric (GE) logo on a building
Source: Sundry Photography / Shutterstock.com

But the stock has bounced 26% since. It touched a four-month high last week. There’s still a lot of work left to do — GE stock is down 36% year-to-date — but finally General Electric seems to be moving in the right direction.

Honestly, I hope that is the case. General Electric remains one of America’s great companies, with a history that dates back to Thomas Edison. It’s one of the country’s larger employers, though its workforce has shrunk dramatically in recent years. Many individual investors have stuck by the company despite disappointing returns of late.

But hope is not an investment strategy — and I still can’t get behind General Electric just yet. The rally of late admittedly makes some sense, and I can see why investors see the light at the end of the tunnel. With earnings due on Wednesday morning, however, I worry that this rally may be another false start for a stock and a company still trying to find their way in the dark.

Why GE Stock Has Rallied

It’s always difficult to suss out exactly why an individual stock has rallied. But it seems likely that optimism toward a recovery from the novel coronavirus pandemic finally has made its way to GE stock.

Indeed, as MarketWatch detailed last week, Wall Street seems to be making that case. An analyst from Wolfe Research called GE the “most compelling COVID-19 play,” in the sense that General Electric has the most to gain from a normalized operating environment. Another sell-sider made a similar argument, calling GE “the most vaccine-levered stock” his firm covers.

I’m somewhat sympathetic to those arguments. I’ve been arguing that investors need to take the long view and focus on the promise of a recovery since the market’s darkest days in March. And I still see a few stocks out there where investors aren’t quite taking the long view. Instead they are focusing on near-term problems.

GE stock may be one of those names. Its GE Aviation unit, in particular, has taken a huge hit as air traffic has plummeted and aircraft orders have been delayed or canceled. Healthcare equipment sales have fallen amid lower elective procedures. Renewable Energy results have suffered as projects too have been pushed back.

General Electric, even on an adjusted basis, lost 10 cents per share in the first half of 2020. The Industrial business was barely profitable even excluding one-time charges and before still-significant interest expense.

The business has struggled for some time, but in a normalized environment, this is not a loss-making company. As that normalized environment returns, General Electric should get back to earnings. Theoretically, that should be good news for GE stock.

Not So Fast

But in practice, there are still reasons for caution, if not outright skepticism.

The near-term problem is that Q3 earnings are likely to still be somewhat soft. Chief executive officer Larry Culp did say last month that he expected his company to generate positive free cash flow in the second half of the year. That would be good news, given that GE for years now has had a notable disconnect between earnings and cash flow.

But since those comments, GE stock has rallied. Expectations may be for something more than a modestly positive print in Q3 and Q4. If Culp has to walk back his forecast, all bets are off.

Meanwhile, as Bloomberg pointed out, the GE board actually amended Culp’s employment agreement around the same time, lowering the required stock price for the CEO to receive a sizeable equity grant.

That in turn goes to the longer-term questions about GE — questions that have dogged the company and the stock since before Culp took over in October 2018. As I wrote after soft second quarter results, this is a company that has only become smaller year after year. It’s been playing defense the entire time, selling units and cutting costs rather than driving real growth.

The hope was that a leaner GE would be a better GE. That hope hasn’t panned out.

Even before the pandemic hit, GE stock had badly underperformed the market during Culp’s tenure. The problem looking forward is that there’s not much left to do. There are no real businesses left to sell. Costs have been cut to the bone.

For better or for worse, what GE is now is what GE is going to be. Investors of late believe that GE is worth owning. I hope they’re right — but I fear they’re not.

On the date of publication, neither Matt McCall nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in the article.

Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. Click here to see what Matt has up his sleeve now.

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