"Immelt, Ahead of the Curve?" Or Behind The Eight Ball?

GE published its 2008 earnings forecast this past week. This made it the subject of the weekend Wall Street Journal's 'breakingviews.com' column, entitled "Immelt, Ahead of the Curve."

I should note, before I go further, that I saw somewhere last week that breakingviews.com is minority owned by Dow Jones, or, I guess, now, Muroch's News Corp, now the publisher of the WSJ. More detail on the company may be found here.

According to Rob Cox, US editor,

"We write for the shareholders. What sets us apart is that we're not 'media critics,' Cox said in an interview Monday in breakingviews' sparsely furnished Midtown Manhattan office. "We are 'company critics.' We look at what deal will make the most sense in value creation, earnings potential and new products."

You could have fooled me. Because, starting with the Journal/breakingviews article title, it appears that they are writing to make sure the Journal retains GE advertising business. For instance, their piece on GE observes,

"Most conglomerates have gone the way of the diplodocus. But GE has long preached the advantages of its grab bag of businesses, ranging from making dishwashers to managing mutual funds. Like a portfolio of stocks, GE's diversified structure can allow weakness in one area to be offset by strength elsewhere. And a smoother stream of earnings helps GE maintain its triple-A credit rating, which is a huge advantage in a crunch."

Let's stop right there. Anyone with a degree in finance and a reasonable knowledge of the field knows that for at least two decades, and especially in modern liquid capital markets, GE-style diversification has long since lost any value for shareholders. I wrote a post about this in July, featuring Immelt and GE. In it, I stated,

"So, in actually, Immelt isn't running GE in order to give shareholders the best chance of enjoying consistently superior (to the market, or S&P500) returns, no matter when they own the stock. Instead, he's pursuing some hoary, forty-plus-year-old goal of 'earnings smoothing' via 'diversification.'

I don't think I've seen a single diversified conglomerate among my consistently-superior, high-growth portfolio selections. Ever.

Conglomerates, as I wrote in the reposted passages above, are holdovers from a bygone era. Managing according to the theory that there is value in diversifying to "ride out the inevitable ups and downs of the economic cycle" is simply being backward in this more financially modern era of liquidity, low/negligible trading costs, and easier risk management via derivatives.

What is surprising to me is that nobody in the business press seems to call the few remaining conglomerates, especially GE, on this issue. GE has become a quasi-index, closed-ended fund, with a big management fee discount from its component values. There is simply no way Immelt, as GE's CEO, is entitled the many tens of millions of dollars he is paid annually to essentially manage an index fund."

If Cox and his minions think they are for shareholders by accepting this lame argument, they'd better think again.

The breakingviews piece continues with,

"Investors remain skeptical, however. At $36.91 Friday, GE shares are down about 6.9% from the day Mr. Immelt took the helm in September 2001. The market may not be giving Mr. Immelt sufficient credit."

Let's take another pause here. Look at that phrase, 'the market may not be giving Mr. Immelt sufficient credit.'

What school of thought is that coming from? The market price is right. Period. That's the price at which you can sell your equity shares. In my opinion, what breakingviews probably meant, or should have written, was something like,

"The market is not currently pricing GE shares at a level that Immelt feels is an appropriate value for the performance of the company."

Meaning, basically,

"Jeff Immelt, like many other whiny, non-performing large-cap company CEOs, has failed to do what it takes to get GE shares priced at a level that would yield a consistently superior return for his shareholders, since he took the helm of the company. He believes the company's operating performance merits a higher price, but actual shareowners who price the stock with their buying and selling value it much lower than Immelt would like. Clearly, Immelt has yet to understand the performance profile that a sufficient number of investors need to see at GE in order to drive the share prices up to levels that outperform the S&P500."

Here's another revealing statement from the Journal/breakingviews piece,

"With half its revenue coming from abroad, many of GE's businesses, notably infrastructure, are still going full steam."

Doesn't this beg the obvious? If some GE units are 'going full steam,' maybe they should be spun off as a separate entity, in order to give shareholders something that can outperform the market while King Jeff I reigns supreme at the closed-end mutual fund cum diversified industrial conglomerate.

My proprietary research on large-cap company performance revealed that slow-growth and fast-growth companies are judged by investors using different key performance benchmarks. When slow- and fast-growth businesses are combined in one company, the faster-growth units suffer in valuation because of the tendency for their slow-growth brethren to drag the firm's overall growth rates down, and, thus, reduce the implied valuation of the faster-growth units.

The article goes on to state,

"The stock historically commanded a 20% premium to the S&P 500, according to Goldman Sachs. That suggests a multiple of 19 times earnings. Assuming GE hits its earnings-per-share target of $2.42 next year, that implies a stock price of about $46. Throw in its 3% dividend yield, and the potential upside looks to be nearly 30% -- all on fairly conservative assumptions."

However, my research found that earnings growth, per se, is not sufficient to raise valuation. Further, to say GE historically has had a 20% premium to the S&P misses the point, doesn't it? Over the past six years, it's underperforming the S&P. So GE's returns in the coming year probably will, again, bear little relation to past market-related multiples. With Immelt at the helm, the company's stock has simply failed to beat the market's returns.

GE obviously has little reason to hope for turmoil in either the global economy or financial markets. Yet, in a strange way, a little uncertainty might just be what is needed to vindicate Mr. Immelt's strategy."

Really? 'Vindicate Mr. Immelt's strategy?'

How? By turning in six bad years, then perhaps outperforming on the seventh? Is Immelt's strategy to collect tens of millions of dollars of shareholder money each year, in exchange for maybe outperforming the S&P500 only about 10-15% of the time?

Does this constitute performance that an investor should want? It's as if breakingviews is counseling,

'Buy GE, and hold it for, oh, seven or eight years. True, you'll underperform the S&P for the first six, but, wow, that seventh year!'

How can the Journal, and breakingviews.com, be so irresponsible? Contrary to Cox's quote about being for the shareholder, I see nothing in this article but more large-cap CEO ass-kissing, CEO interview access and advertising protection.

Why don't the authors, John Christy and Robery Cyran, quantitatively determine the added risk of holding GE stock, while it underperforms the S&P? And how much less risk, and better performance, their readers would get over, say, a decade of Immelt-like performance at GE, by simply buying and holding a Vanguard S&P500 Index fund?

I can only conclude, sadly, that the Journal, because of its minority interest, gives breakingviews.com this highly-visible real estate on the back page of the Money & Investing section. And, because the Journal needs corporate advertising and access, breakingviews is careful to avoid being too candid in its remarks about companies like GE, and their CEOs.