Buying a good company when it’s out of favour is a proven strategy for building wealth.
Consider General Electric Co. At the height of the financial crisis in February, 2009, the industrial giant slashed its dividend by 68 per cent, hammering its already beaten-up shares.
If you had nerves of steel and bought the stock right after the cut, you’d be up a cool 272 per cent (in U.S. dollars), including dividends.
That’s easy to say in hindsight, of course. At the time, the company – and its GE Capital unit in particular – were facing a frozen credit market and rapidly deteriorating economy. Things looked bleak, and taking on risk was the last thing many wanted.
But the situation is very different today. GE is on more stable footing and the economy is in much better shape, yet GE’s shares have hit a rough patch. They’re down more than 12 per cent in 2014, in part because investors were disappointed that its industrial profit margins didn’t expand as much as expected in the fourth quarter.
Here are five reasons that GE might be worth another look in light of the recent share weakness.
1. The dividend is growing again
Since the 2009 cut, GE has raised its dividend six times. The quarterly payment has more than doubled in that time, and the stock now yields an attractive 3.6 per cent. Analysts see more hikes on the horizon. “Going forward we expect dividends to grow roughly in line with earnings,” Edward Jones analyst Christian Mayes said in a recent note. Dividend hikes signal a company’s confidence about the future, so the resumption of growth is a bullish indicator.
2. It’s a global leader in key industries
Mention GE and most people think of light bulbs and refrigerators. But the company is also a leading manufacturer of aircraft engines, locomotives, wind and gas turbines, medical equipment and myriad products used in the oil and gas, water, mining and power industries. More than half of GE’s revenue is derived internationally, giving it significant exposure to infrastructure development opportunities in emerging markets.
3. Much of its revenue is recurring
About 40 per cent of revenue in GE’s industrial business is recurring from service and maintenance work, which has profit margins twice as high as equipment sales, Mr. Mayes said. “When GE sells a new engine, turbine or locomotive, it can also benefit by providing maintenance for the next five to 12 years,” he said. This provides a stable source of ongoing revenue.
4. The company is “de-risking”
Aiming to reduce credit risks and return to its industrial roots, GE wants to shrink the proportion of earnings from GE Capital – the source of steep losses during the financial crisis – to about 35 per cent from 45 per cent. To that end, it plans to divest its North American retail finance business, which offers store credit cards and other services, with a partial initial public offering in 2014 followed by a spinoff of the remainder of the unit in 2015.
Even before the consumer finance divestment, “GE Capital has improved dramatically in recent years. The business is now smaller, more focused and better capitalized. External conditions are more favourable and several key competitors have left the market,” Odlum Brown analyst Stephen Boland said in a note.
5. The stock is reasonably valued
GE trades at about 14.5 times estimated 2014 earnings, which is down from a multiple of more than 17 times late last year and roughly in line with the five-year average, according to Bloomberg. Mr. Mayes rates the stock a “hold,” calling the shares “appropriately valued.” Mr. Boland rates GE a “buy.”
“GE is a great business. The company’s scale, reputation, technical expertise and knack for generating efficiencies are formidable strengths,” Mr. Boland said.
“Furthermore, GE is usually the leader in its markets and tends to operate where competition is limited. This helps GE generate attractive profitability.”
Mind the risks
Every stock comes with risks. For Canadian investors, a rising loonie would depress the value of GE and other U.S. stocks when priced in Canadian dollars. What’s more, GE is heavily exposed to the global economy and its results would likely suffer in a downturn. Although GE Capital is getting smaller, it would still suffer in the event of another financial crisis.
Keeping those risks in mind, for long-term investors GE offers a diversified play on the global economy and emerging markets, with a rising dividend and attractive yield backed by growing earnings.