By
Chuck Carnevale
:
<< Return to Part 1
Jeffrey R. Immelt is only the 12th person to serve as leader of
General Electric Co. (
GE
) since Thomas Edison founded the company in 1878. Upon taking over
the reins of this great American corporation, Jeffrey R. Immelt
faced two difficult challenges: First, he had to fill the shoes of
Jack Welch, one of the most respected CEOs in all the world.
Second, he took over the reins from Jack with General Electric
trading at one of the highest valuations it ever had.
The following earnings and price correlated F.A.S.T. Graphs™
looks at General Electric Co. when Jeffrey R. Immelt first took the
reins up to just before the great recession of 2008. There are two
points that I emphasize with this graph. First, in order to be fair
to Mr. Immelt, we should acknowledge that General Electric was
significantly overvalued when he took charge. Second, we should
give him the same credit we gave Jack Welch regarding operating
results.
Mr. Immelt orchestrated a steady and above-average earnings
growth rate of 8.9% (the S&P 500 grew earnings at 5.7% per
annum during this same time frame). However, when we look at the
performance results associated with the earnings and price
correlated graph from 2001 to 2007, we discover that shareholders
had a negative total return, even when considering dividends. But
my point is, the culprit was over-valuation, not poor management of
the business. From the standpoint of rewarding shareholders, Mr.
Immelt was behind the eight ball from the get-go because he
inherited a highly inflated company.
(Click to enlarge)
(Click to enlarge)
The Full Jeffrey R. Immelt Era
When we look at the complete Jeffrey R. Immelt Era by looking
beyond 2007 up to and through the great recession, we discover real
reasons for General Electric's recent poor performance. A major
fact of the Jack Welch legacy was an aggressive campaign in the
early to mid-1990s to make General Electric a dominant player in
the growing financial services sector. Consequently, by the end of
the decade financial services revenues grew from a mere 25% to 30%
in the late 80s, to over 60% of General Electric revenues by
1996.
Therefore, mostly attributable to the financial debacle of 2008
and 2009, General Electric, with its huge exposure to this sector,
saw earnings fall 16% in 2008 followed by a 44% drop in 2009. As
the following earnings and price correlated graph illustrates,
General Electric's stock price followed their earnings down. From
the accompanying performance chart we also discover that this
financial stress forced General Electric to cut their dividends by
34% in 2009, and an additional 49% in 2010.
On a more positive note, General Electric today is a more
balanced conglomerate than it was just prior to entering the great
recession of 2008. The newly named GE Capital provided just 30% of
revenues for the fourth quarter of 2010. And most importantly, GE
Capital is once again contributing to the firm's profitability as
the financial services business is steadily improving. And overall,
General Electric has begun growing earnings again, which have led
to three modest dividend increases in the last 12 months.
Nevertheless, even when considering all the mitigating factors,
General Electric shareholder returns under Jeff Immelt have been
less-than-satisfactory and below-average. As a result, this once
beloved Wall Street darling has become reviled by most investors.
On many levels I find this ironic because I remember being severely
chastised for warning shareholders about the extended valuation of
General Electric shares in the late 90s. The stock was going up,
Jack Welch was a genius and how dare I criticize this great
American company.
(Click to enlarge)
(Click to enlarge)
General Electric - The Last 20 years
The following graphs summarize what has been written in this
article thus far. A picture is worth 1,000 words and the following
pictures speak volumes about what really happened with this great
American business and its recent history management team. We see a
solid earnings growth record where both Jack Welch and Jeffrey
Immelt contributed. We also see how the company was punished during
the great recession by focusing more on services than
manufacturing. Jack Welch started it, Jeff Immelt inherited it, and
he is left with the job of fixing it.
Additionally, the following pictures also tell us a lot about
valuation based on emotion rather than fundamentals. The excessive
overvaluation we saw during the irrational exuberant period was
painfully and rapidly corrected when General Electric's
profitability growth slowed down from 2002 to 2005, even though it
continued to grow modestly. However, after General Electric's stock
price reverted to the mean, their stock price once again tracked
earnings up to and through the great recession and into the current
recovery. Finally, through the associated performance chart we see
the blemishes on dividend growth that earnings weakness
created.
(Click to enlarge)
(Click to enlarge)
This last graph shows the same picture logarithmically. The
relationship between stock price and earnings is clearly evident
when examining this graph.
(Click to enlarge)
General Electric - The Future
The following estimated earnings and return calculators are
based on consensus estimates of leading analysts reporting to
FirstCall and Zacks. The first graph shows that the consensus
estimates of 14 analysts reporting to FirstCall expect General
Electric to grow earnings by 15% per year for the next five years.
If General Electric succeeds in achieving these earnings growth
targets, the implied annual rate of return at year-end 2016,
assuming a normal PE ratio of 15, would be 18.3% per annum
including dividends.
(Click to enlarge)
The following five year estimated earnings growth rate, provided
courtesy of MSN
Money
, reports that the consensus of approximately 11 analysts reporting
to Zacks expect a slightly lower earnings growth rate of 12.4% per
annum over the next five years.
(Click to enlarge)
If the Zacks' estimates are correct, then General Electric would
still amply reward shareholders with a 16.3% estimated total return
over the next five years. Implied in both of these estimates are
dividend increases consistent with the expected growth rates.
(Click to enlarge)
The following earnings yield estimator is based on General
Electric Co. achieving the FirstCall estimated earnings growth over
the next 10 years. Although I recognize that making a forecast 10
years in advance is fraught with peril, it is offered only as a
"what if" scenario. The focal point for offering this graph is the
dividend growth yield opportunity, or what many like to call the
yield on cost potential going forward. This would represent the
primary reason why dividend growth investors might want to consider
forgiving General Electric.
(Click to enlarge)
Watch the following video for a live interactive version
of the above presentation.
General Electric in Pictures
As we all know, General Electric is one of the largest and most
diversified conglomerates in the world. General Electric organizes
its businesses into the following five segments: GE Capital
approximately 30% of revenues, Technology Infrastructure
approximately 25% of revenues, the newly reorganized NBC Universal
representing about 12% of revenues, Home and Business Solutions
representing about 6% of revenues, and finally Energy
Infrastructure representing about 27% of revenues.
During their most recent earnings call, management reported that
they expect to increase research and development spending by more
than 12% in 2011. Additionally, CEO Immelt recently reported that
General Electric has a target of boosting research and development
spending to 6% from 2% of industrial revenue. This most recent
increase has achieved that goal, and therefore, no further
increases of R&D spending are indicated. If General Electric is
capable of meeting the consensus analysts estimated growth targets
reported above, these research and development expenditures and
efforts will need to bear fruit.
However, due to the complexity of this highly diversified
industrial conglomerate, a full detailed review of their R&D is
beyond the scope of this article. On the other hand, since a
picture is worth 1000 words the following excerpts taken directly
from the GE research section of their website provides insights
into the complexity and the opportunity that many of their projects
offer. The first set looks at industry opportunities, followed by
technology initiatives.
INDUSTRIES
General Electric Global Research Labs is developing initiatives
across numerous industries to include:
- Appliance initiatives developing magnetocaloric
refrigeration, the next generation of refrigeration technology
and smart grid solutions to reduce power consumption and save on
electricity costs for homeowners and business owners.
- Aviation initiates developing titanium alloys and other high
pressure casting techniques reducing the weight on jet engines
and ceramic matrix composites combining heat resistance and
strength.
- Electrical distribution initiatives such as scientific brains
making the grid smarter and ultimate circuit breakers providing
faster response to power surges.
- Energy initiatives such as clean power from the wind and sun,
and super-efficient flex-fuel gas turbines.
- Healthcare initiatives including electronic medical records
and advanced imaging agents.
- Lighting initiatives such as the smart light florescent
technology that illuminates the homes flickers and eerie glows
and brilliant LEDs and organic light emittiming diodes
(OLEDs).
- Oil and gas initiatives include subsea electrification and
sea floor oil platforms.
- Transportation initiatives include a megahybrid fleet
utilizing advanced hybrid batteries for tugboats, mining trucks,
busses, and even passenger cars.
- Water Initiatives such as advanced desalination technologies
and methods for extending the life of water.
TECHNOLOGIES
General Electric is developing numerous exciting advanced
technologies. They include sustainable energy, advanced propulsion,
nanotechnology, advanced electronic materials systems, molecular
imaging and diagnostics and energy conversion.
In biosciences, GE is working on methods for removing cancer,
growing cells outside the human body, and using molecular pathology
to change the way we see disease.
General Electric is also developing chemical technologies and
materials to include the next generation battery for the hybrid age
and advanced storage capabilities.
In electrical technologies and systems, it is developing
technologies, products and infrastructure for electric vehicle
integration, integrated circuits that can withstand high
temperatures and methods for reining in the sun to bring renewable
energy onto the electric grid.
In energy and propulsion, it is developing diesel engines and
state of the art gas turbine technologies to reduce emissions and
operate on a variety of fuels.
The following images taken directly from GE's website provide
photographic examples of exciting developments in manufacturing and
materials technologies and software sciences and analytics.
(Click to enlarge)
From the above it should be clear that General Electric is a
complex organization with many intriguing opportunities covering
numerous industries. It would be hard to not acknowledge the growth
potential that most of the above projects potentially could provide
General Electric. From what the above depicts, General Electric's
future could be both interesting and highly profitable.
Conclusions
I have recently read many articles covering General Electric Co.
and its stock. Most of these articles were focused on General
Electric's resurgence as one of America's great companies. However,
due to its stock performance over the past decade, especially over
the last five years, these articles were met with strong and even
heated objections by many readers. Therefore, a great motivation
for my interest in authoring this article was to cast a light of
truth on what really occurred with this company and its recent
management.
Jack Welch does deserve a lot of credit for the job he did as
CEO of General Electric. However, he is often given much more
credit for General Electric's stock price action than he truly
deserved. Much of the performance under Jack's reign was the result
of excessive valuation more than strong operating performance. In
other words, the excessive price rise was not Jack's fault, but he
deserves recognition for the operating excellence he achieved.
In contrast, Jeff Immelt does not deserve all the criticism that
has recently been thrown at him. He inherited a massively
overvalued company with a large and arguably out of control
financial services segment that he did not create. Jeff joined GE
in 1982, and served as president and CEO of the GE Medical Systems
segment, a unit with $12 billion of revenue. Therefore, I would
argue that the true Jeff Immelt legacy has yet to be written. As
General Electric Co. looks to the future, Jeff Immelt's skills and
abilities as chairman and CEO are yet to be fully recognized.
But the most important reason that I wrote this article was to
illustrate how price action, even when it's irrational, can color
people's views about a company and its investment merit. In many
cases, stock price action may or may not be representative of the
respective company's true intrinsic value. However, most people
take their cue from price action while mostly ignoring fundamentals
altogether.
At today's price and valuation, General Electric Co. offers the
dividend growth investor an above-average yield with the potential
to grow at an above-average rate. The truth is that General
Electric is a great American company, and the truth is that the
market once priced this company beyond what their fundamentals
justified. And, it's also true that the company recently faltered,
but its most recent earnings reports indicate that it has begun
righting the ship.
But the biggest truth, is that General Electric Co. is a solid
franchise with intriguing growth prospects. As investors we should
never forget that we are always buying the future not the past.
Although I've never owned this blue-chip, I have often longed to.
However, as this report illustrated, it was very difficult,
especially during its heyday, to invest in this company at a
reasonable price. Yet, when it was overvalued, was also when
everybody wanted to own it. But now that General Electric Co.
appears to be reasonably priced with a solid and potentially
growing yield, investors are loath to own it. I believe it's at the
very least, worthy of further research.
Disclaimer:
The opinions in this document are for informational and
educational purposes only and should not be construed as a
recommendation to buy or sell the stocks mentioned or to solicit
transactions or clients. Past performance of the companies
discussed may not continue and the companies may not achieve the
earnings growth as predicted. The information in this document is
believed to be accurate, but under no circumstances should a
person act upon the information contained within. We do not
recommend that anyone act upon any investment information without
first consulting an investment advisor as to the suitability of
such investments for his specific situation.
Disclosure:
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours.
See also
Large Cap Bargain Bin: Time to Make Your Shopping
List
on seekingalpha.com