A few months back my friends at CNBC asked if I could come on "Closing Bell" and provide the bear argument for General Electric (GE - Free Report) . Now normally, I am bullish and spend most of my time on tech stocks, but let's face it, when CNBC asks for me by name (and not just any person at Zacks) I will do what they ask.
Hindsight is always 20/20, but at the time there wasn't that much cause for concern on shares of GE. When you are asked to appear on a show for any TV outlet, you have to speak to the producers who are vetting your story. In this case, I put together a few talking points and emailed them over.
In the end, the segment never made it to air as plans changed. What I was left with was a bunch of good information that I more or less shelved until now.
In giving a mega-cap like GE a good looking over, I started with a 50,000-foot view and just looked at earnings and revenue. The first thing that stood out at the time was that the company hadn't missed in 5 years. That tells me that earnings are managed and while a bad quarter can hit at any time, at least management likely preannounced.
In looking at the top line, the results just weren't as "smooth." 10 of the last 14 quarters had seen a negative revenue surprise, which is to say the company missed on the top line a lot. As of June of 2017, the stock had traded lower following earnings releases for each of the last six quarters.
So while none of this is damning, it isn't what you want to see.
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In Mid May of 2017, the CEO bought 100K shares and a director purchased 16K shares and another director bought 4K shares.
These buys acted as a vote of confidence in the restructuring plan that was supposed to cut costs by $1B in 2017. The problem there was a lame duck CEO doesn't carry the same authority and a new boss will likely install new upper management and probably a new CFO too.
There is an old Wall Street adage that basically says "give me a year" - and that is what a lot of institutional investors want to see first. They want to see management guide the company for a year before committing any more capital to the stock. This phrase often comes along with new CEO's and IPO's.
Thing is, GE was in trouble and the shorts knew that the big players were probably less likely to be adding to their positions in the stock. That meant that selling short was probably going to be a good deal less risky.
Deutsche Bank had recently downgraded the stock to sell based on weak quality of earnings and a wide gap in non-cash and cash earnings. The report also warned (correctly) of an earnings reset with new management.
There was also plenty of warnings signs that there could be a substantial dividend cut looming.
Returns Of Cash
One of my bullet points to the producers are CNBC was that I felt the name of the company shouldn't be General Electric as much as it should be Dividend Electric.
The company talks a lot of about cash returned to shareholders, so I wanted to see exactly what that was. In the most recently reported quarter, the company had repurchased $2.3B in stock and paid $2.1B in dividends.
Often times the repurchase of stock comes when executives and other insiders are selling stock and the company buys in back as part of a buyback program. I am not saying that insiders sold $2.3B, but those buybacks also come when big institutions might be looking to exit a position as well.
Here Comes The Rub
So all of this information was out there already, and anyone could have seen this with on a few minutes of basic research. What came next was the foundation of why I could really get behind a bearish stance on this company.
I looked at Inventories and I saw a good size build over the last few years. Here is the chart that I sent along to CNBC:
The clear view here is an annual build of in inventories and when you compare that to the slide in sales...
You have a nasty picture starting to take shape.
Value Investors Take Note
So this is clearly not what you want to see when you are a growth investor, as I am, but maybe the value investors out there would like this story. Maybe they see something good here.
I looked at the primary measure that value investors tend to lean on, price to book. Value investors really want to own something for less than what it is worth, so a price to book multiple of less than 1 is great and anything over 3 is basically not worth their time.
At the time, here was the table of where the GE book multiple had been over the last several years:
The thing that jumped out at me is that we were at multiple levels that were basically back to the highs of 2007. Over the last 10 years, GE has been selling off businesses right and left, yet somehow the market was telling us that what remained was somehow worth more -- even with the stock falling?
I compared the book multiple to other conglomerates and this is what I saw:
I know this image isn't super cleat but the white line is the industry average for price to book while the yellow line is GE over the last 10 years or so. The industry has recovered but GE has not... at least not fully.
To me, the story was that GE was selling business units and that caused sales to drop. The build in inventories was substantial over the last few years and the calls for a reset were getting really loud. With growth investors almost nonexistent, value investors stretched and new management on the way in, being bearish on this stock was not that hard of a call to make.
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