GE Stock: Cheaper, but Still No Bargain

A closer look at the combined value of GE's components shows that, despite a drop of one-third in the past 12 months, the stock may be overpriced

Jack Welch's 20 years in the role of General Electric CEO has been a bravura performance in most every way. Welch, who is set to step down on Friday, Sept. 7 after a final board meeting, took GE (GE ) from No. 8 in the ranks of companies by stock-market value to No. 1. He succeeded in applying his famous "No. 1 or No. 2" dictum to GE's ultimate product, its stock. He did so by "branding" it with the twin hallmarks of financial strength and profit growth, plus an eerie, cyborgian consistency. GE is, in fact, strong, growing, consistent. What GE isn't is cheap.

This is true despite a forgettable past 12 months that have seen GE surrender nearly a third of its market value. From $60.50 a share last August, GE lately is trading near $42 (chart). With a market value of $415 billion, it remains comfortably ahead of No. 2 Microsoft (MSFT ), at $335 billion. But instead of paying 45 times estimates of the coming year's profit, as they did a year ago, buyers of GE today pay just 26 times.

If you ask me, that's still no bargain. One reason is simply the improbable task faced by Welch's successor, Jeffrey Immelt, in greatly expanding GE's profitability. Welch widened GE's margins to more than 20%, from 9%. That proved to be a mighty lever in delivering consistent annual profit growth near 15%. Common sense suggests such a boost will be harder to come by.

Even if Immelt somehow overcomes those odds, there's no escaping the extravagant premium that remains built into the company's stock-market value. To see what I mean, evaluate GE with me by its eight operating segments (table). I first figured the profit each segment generated in the 12 months ended June 30. Next, to put a reasonable earnings multiple on each segment, I looked at their records of growth in sales and earnings, at their competitors' market multiples, and at multiples paid in mergers. In each segment, I granted GE the benefit of the doubt and erred on the high side. For example, Whirlpool's (WHR ) market value is $4.6 billion, six times its operating profit over the past four quarters. Maytag's (MYG ) multiple is a bit below 10. Giving GE Appliances an operating profit multiple of 10, I estimated its worth at $6.4 billion.

Make no mistake, this is back-of-the-envelope stuff, which became most hazardous with GE's giant financial arm, GE Credit Services. Its eclectic, $376 billion portfolio, from credit-card receivables to real estate loans and insurance contracts, makes GECS a cross between odd duck and golden goose. I settled on 24, a multiple between those enjoyed by slower-growing Citigroup (C ) (18 times net profit) and less-leveraged American International Group (AIG ) (30 times). That indicates GECS is worth $134 billion, or 0.36 times its assets. In a pending deal for Heller Financial (HF ), GECS is paying 0.27 times assets. Tyco International (TYC ) in June paid 0.2 times assets for CIT Group.

Despite granting GE premium multiples, the sum of my estimated values for its eight segments still came only to $325 billion, or $32.50 a share. Could that be right? Could the market still be so wrong about a company that's so well-known on Wall Street? GE thinks so--but in the other direction. "The stock is undervalued" at $41, a spokesman told me. "We believe that if you have the right parts, the whole will be greater than the sum of the parts."

Yet, if you find yourself tempted by GE, bear in mind just a few more facts. In 1981, the year Jack Welch became CEO, GE'S market capitalization was less than $14 billion. Not until 1995 did it cross the $100 billion threshold. Then, in the next five manic years, its value soared to nearly $600 billion--a sixfold increase even as profits did not quite double. Now, suppose investor enthusiasm were to cool. Suppose GE's stock were to retreat to its 1995 multiple of 15. It then would sell for $22 a share.

By Robert Barker

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