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GE Underperformance

 
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PostPosted: Sat Apr 08, 2006 2:07 pm    Post subject: GE Underperformance Reply with quote

OUTSIDE THE BOX
Playing GE in an uncertain market
Commentary: Industrial giant has lots to offer investors
By Michael K. Farr
Last Update: 2:55 PM ET Apr 8, 2006

Michael K. Farr is president and majority owner of Farr, Miller & Washington, LLC, a Washington DC-based wealth management firm.
WASHINGTON (MarketWatch) --

So far in 2006, the Dow Jones Industrial Average is up 4.7%, the S&P 500 is up 4.9%, and the Nasdaq is up 7.1%.
In a market like this, it's relatively easy to look smart as the rising tide helps to lift all boats. However, it gets more difficult to pick winners when faced with a more neutral market backdrop, as we expect for the balance of 2006. So, following the best first quarter for the stock market since 1999, I am increasingly asked where to find value for the weeks and months ahead. My answer is a stock that has surprisingly not participated in the market's recent move, despite our expectation for double-digit earnings growth for the foreseeable future. This company is none other than that stalwart of the global economy, General Electric (GE : General Electric Company)
Last: 34.03-0.48-1.39%

5:01pm 04/07/2006

For all its positive investment attributes, GE's stock has been stagnant not just in 2006, but for the past three years. At 17.3x the consensus estimate for 2006 EPS, the stock currently trades at just an 8% premium to the market multiple. We find this puzzling given GE's status as "most admired" as labeled by Fortune and Barron's magazines, and as "most respected" by the Financial Times newspaper.
For our part, we view GE as a carefully constructed and diversified portfolio of industrial and financial businesses, all run by a world-class management team.
We acknowledge that the company has run into some difficulties over the past few years as CEO Jeff Immelt initiated his strategic vision for the company. However, it now appears that the foundation has been laid for solid, highly visible earnings growth in the years ahead. And importantly, this growth appears to be relatively immune to a U.S. economic slowdown -- an eventuality we view as more likely than not over the coming year. We believe investors should pay a premium for this type of growth in today's environment.

Visibility
GE's strong earnings visibility comes from four factors.
First, the company has been selling off low-return, slow-growth businesses and investing in growth platforms. CEO Jeff Immelt initiated this strategy shortly after becoming CEO in 2001. Capital-intensive insurance businesses have been replaced with investments in businesses such as security, water, oil & gas, consumer finance, and Hispanic broadcasting. These investments should pay off in the form of higher revenue and earnings growth in the years to come.

Second, GE's global diversification into underdeveloped markets makes it less dependent on conditions in the US and other developed nations. In fact, management expects that over half of total company growth will come from emerging markets in the coming years. Given the fact that these economies are less correlated with the U.S. economy, we believe GE's growth is more predictable.

Third, GE's recurring services revenue is expected to be a larger contributor to total company revenue as the installed base of GE equipment has grown over the years. Services revenue is generally considered to be relative stable, recurring and highly visible. Immelt's concerted effort to grow this part of the GE story is clearly a strong positive, in our opinion.

And finally, GE's industrial businesses run on longer cycles than most other U.S. industrial companies. Therefore, the company's current backlog of orders can predict sales further out into the future. As well, a sudden economic shock in the U.S. or elsewhere may not be as painful to GE.

Management
The last piece of our investment case is GE's management team. In a nutshell, CEO Jeff Immelt is our kind of manager -- aggressive, straight-talking, and plenty of skin in the game. Mr. Immelt recently decided to forego his 2005 cash bonus in favor of "GE performance shares," half of which can be redeemed only if GE shareholder returns meet or exceed those of the S&P 500. The other half of the performance shares are redeemable only if certain cash flow targets are met. One hundred percent of the value of Mr. Immelt's bonus is at risk.

We find this kind of confidence refreshing and would like to see more CEOs take this kind of performance approach to their own compensation.
I recently ran into Mr. Immelt and took the opportunity to pick his brain about different issues. I asked him if he would be attending the World Economic Forum in Davos, Switzerland. As the leader of one of the biggest companies in the world, I figured his presence would be helpful, if not required. To my surprise, he said his time was better spent in Japan, where he was heading to ensure a productive marketing effort for GE's line of diagnostic imaging machines. This is the type of attitude I love to see from the head honcho of one of our favorite companies!

With its outstanding management team, consistent and highly visible earnings growth, and attractive dividend, we believe GE is an outstanding candidate for investors seeking stability in the uncertain world. The upside potential is quite strong while the downside risk is limited at today's price. We believe investors will come to value GE's stability and visibility more and more as the seas become choppy in days ahead.

This article is not a recommendation to buy or sell any security. Farr, Miller & Washington, LLC owns shares of General Electric for its client portfolios, and the authors own shares of General Electric in their personal accounts. FMW may be adding or paring positions in the future as appropriate.
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