Market Chasers

General Electric (GE) : Why is this a buy?

July 4, 2008 – 3:29 pm

HAPPY FOURTH OF JULY!

Article Notes:

-Great long term alternative energy technology

-Great statement of cash flows sheet.

-High financial leverage, great future ROE potential.

For my first article, I have chosen GE.This is hands down my most favorite stock in this world, beside American Express (AXP) and Consolidated Edison (ED), both of which I will be writing articles for in the very near future. I own this for my personal portfolio and you should as well. This global conglomerate has been hit hard but I will plea my case on why this stock is a BUY BUY BUY!

Where to begin you might ask, and why would I be recommending this stock to you? Ratios for this company, we can go ahead and throw out of the window for a few reasons. First, the basis of ratios is to compare your company, which in this case is General Electric, to other companies that are related to the company in question. If not, it would be like comparing apples to orange. For example, you cannot compare General Electric to lets say a financial stock like Bank of America. Bank of America has a lower P/E but does that necessarily make it cheaper? No. Another reason you cannot use ratios is similar to the one just stated but there are no companies out there like GE. Can you make me another company in this world who can make jet engines then turns around and make photovoltaic solar panels? Again, you can’t.

Every companies P/E has been decreasing due to the fact that these companies are having trouble bringing home the bacon. Kind of hard to sell product during a recession don’t you think? You cannot look at a low P/E or a low PE/G as a reason to buy but GE is a special case. Now there is a small exception to this which are your consumer defensives like Procter and Gamble. It’s not like your going to stop buying diapers for your 6 month old child just because the U.S economy is in the heart of a recession.You need to be looking at this company as a global growth stock that has been hit and is searching for the bottom. The rate at which GE performs is completely dependent on the status of the economy because of the types of services and products it offers, go figure but this is something many investors forget.

Lets look at some financial statements….

First and foremost, whenever a analyst tells you that a company has a great balance sheet or a strong set of financials, most people just nod their head and agree but do you know what it actually means? Let me explain. First, lets compare GE’s 2007 financials, compared to their first quarter of 2008(I will touch up this article once GE’s second quarter financial statement is released, which will be VERY soon). There are 3 main statements we will be looking at here: the balance sheet, income statement and my most favorite of all, the statement of cash flows, which is my opinion the indicator of a long term growth company.

Balance sheet:

Lets calculate some internal ratios. These ratios are ones we can actually calculate and use to evaluate internally within the company and actually do mean something, opposed to what I said earlier about throwing others out the window. With a ROE of 3.71 and a ROA of of .51, we can calculate that the company has a financial leverage (FL) ratio of 7.275. Basically we are using this equation:

ROE = ROA x FL

What ROE means is that for every dollar in shareholders equity, the company is making approximately 3.71 cents which is quite a low number. ROA is almost identical with every dollar of assets the company has, the company is making .51 cents. Financial leverage is basically how well the company uses debt to make a profit. The higher the financial leverage number is, the higher the ROE number will be. Adversely, with a high FL, if the company is not making as much as expected, the ROE will be dragged down and can actually hurt the company because of the high amount of debt we see. Now if you look at GE’s balance sheet, this is evident because of the recession the economy is in. with a 7.275 FL ratio, which I might add is HUGE, they have a bit of debt right now, but that necessarily isn’t a bad thing. With the strong management that GE currently has, the Financial Leverage can be used in the future to raise up that Return on Equity once the economy straightens out and income increases. Looking at the companies cash to current liability ratio for the first quarter of this year things aren’t very nice either. With a debt to cash ratio of 4.159, the company basically has 4.159x more short term debt(debt due within one fiscal year) then the cash available, and that is COUNTING net receivables which technically isn’t cash yet. Compare this with GE’s 2007 second quarter balance sheet where their current cash equivalents outpaced their current debt by 2-1, you can see that we have fallen far from the fruitful tree. With all this negative news, should you be worried?

Income statement:

This statement is quite easy to read and I will go over it very briefly. Basically what this statement shows is the amount of revenue minus expense which equals net income. Net income is money the company actually earns after all expenses, including income tax. Net income does not include dividends though. All there is to say here is that GE had a nice uniform net income growth rate is quarters past, even in the 4th quarter of 2007. With the first quarter earnings of 2008 released, the net income dropped to 4.304 billion, almost a 2.2 billion dollar drop for the fourth quarter of 2007. Worried?

Statement of cash flows:

Ahh yes, my most favorite statement of all. The SCF is dividend into 3 sections: Investing, Operating and Financing. I am sure you can guess what type of activities fall into each. What you do not know is the direction of cash flow and how it effects the company. Lets start out with Investing. First and foremost, investing cash flow MUST and I mean MUST be negative in order for me to even consider doing a long term investment, and even short term for that matter. Why negative you ask? Because a negative investing cash flow number indicates that a company is spending money(OUTFLOW OF CASH) to grow the business. GE’s outflow from investing dropped about 8 billion but is still at negative 21 billion so you can rest assured that the company is still growing. A positive investing cash flow rate means that the company is selling off long term assets to pay off debt and is going to sink like a stone. Next, lets look at operating. This one is fairly straightforward. You want positive operating cash flow. Basically if its positive, it means you are bringing money into the company. GE still has a positive operating cash flow but has dropped significantly as you could imagine. Lastly, lets look at financing. Financing is basically money bring spent or made from stock as well as activities such as loans. Here, you generally want a positive financing number, which all ties back into financial leverage as stated above. Greater financial leverage means a greater potential for return on equity. GE had a slightly negative financial cash flow number, but that necessarily isn’t bad. The financial cash flow number could be negative and good. How you might ask? If a company is paying dividends and buying back stock at a torrid pace, is that a bad thing? I think not.

Now with all of the negative news I have said above, how could you possibly invest in this company?

You need to look at it this way. This recession the economy is in is like a gift from God and you need to view it in that sense. You are getting very cheap entry points into companies. GE closed this past friday at $26.91 a share, almost a 50% discount from when it was at it’s 52 week high. This isn’t the only company who is like this. I have said this many times but financials will be the cash cow once the housing mess,inflation and oil crisis gets straightened. With many financial institutions selling at greater than 50 or 60 percent off of their 52 week highs, my favorite company is Wells Fargo (WFC).The hard part is catching the bottom. Looking at it this way, since the inception of the Dow Jones Industrial Average, when has the U.S economy ever had a loss over a 10 year period? Never. The big reason why I am investing this stock is due to the green movement. I am an absolute firm believer that the green movement will be the next tech-type boom. Solar energy, geothermal energy, wind energy and clean burning cars will be making people very wealthy in the near future. When GE has invested heavily into the development of their solar panels and wind turbines, how can you go wrong? Almost all of the offering in their product line are devoted to a cleaner, more efficient world. With the amount of money that this company has going into research and development, can you pass this up? The company has also seen a bit on insider trading recently with high officials buying up shares. This is always a positive thing.

GE is currently 15 points off of its 52 week high set in October of 2007 and is continuing to slide. This makes it a great buying opportunity. The best strategy to use for this company is to buy now and if the company continues to slide, increase your position and set a dividend reinvestment up for this with your broker. A company like GE in my opinion is like a roach motel, you can check in but you will never check out(Implying you will never sell). With a dividend rate of 4.65% and growing as the price of the share drops, you can see why you can take advantage of dividend reinvesting. Look at the continuing drop as a clearance sale with a coupon clipping added onto the savings.

I will be writing a follow up article once the second quarter earnings and statements are released.Thanks for reading.

-Justin Moon, Senior Writer for marketchasers.com