Investor Relations

Investor Explains Doubts about GE

A buy-low strategy would favor going all-in on General Electric, but Amazon may be a better bet, despite its ambivalence on earnings.
Vitaliy KatsenelsonMay 1, 2018
Investor Explains Doubts about GE

A lot of times I won’t have an insight into a business because I don’t understand it or because it’s too complex. General Electric is a great example.

Vitaliy Katsenelson

As a value investor I should be all over this iconic stock, which is making a generational low.

But no, not at all. I have looked at GE at least half a dozen times over the years, and always walked away without understanding the business or what it’s worth.

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To make things worse, despite GE being one of the most-admired U.S. companies, I have always hated its culture. Former CEO Jack Welch went into the corporate history books as perhaps the best American CEO ever. I’d argue that’s a history that needs some serious rewriting.

Welch built a company with a “beat this quarter” culture. His GE was not in the business of building moats and investing for the long run. He was in the business of beating quarters.

In his 2001 book “Straight from the Gut,” published the year he retired from GE, Welch raved that the company always beat Wall Street estimates. He was proud of how managers of one division were able to “come up with” a few more cents of earnings if another division fell short of its forecast. I kid you not. If I was at the SEC I’d be investigating GE’s accounting.

GE played games with its earnings for a long time, but in reality its cash flows couldn’t cover its dividend, which was supposedly half of its earnings. That triggered a wake-up call for investors.

It’s always useful for CFOs to understand investor behavior. In that vein, I will tell you that this is another reminder that it’s incredibly dangerous for an investor to own a stock just because the dividend is attractive. Consistently recurring dividend payments create an optical illusion that the dividend will always will be there. Think about it: General Electric’s dividend of 96 cents was half of what the company was expected to earn, and GE still couldn’t afford to pay it.

Welch is on the opposite end of the spectrum from Jeff Bezos, founder and CEO of Bezos doesn’t even know how to spell quarterly earnings. He has explained that Amazon makes decisions years out. So the current quarter’s report reflects decisions Amazon made several years ago.

As an investor, I don’t want to own companies that are run by the likes of Welch. On the other hand, my firm does have positions in a few companies with CEOs who have similar approaches as Bezos does to running a business. (We don’t own Amazon shares, though.) Whenever you hear management praise their ability to beat last quarter’s earnings, run.

General Electric ultimately was deeply wounded by enormous capital misallocation. Management assumed that anything they touched with Six Sigma (a process designed to improve a company’s operations) would turn to gold, regardless of the price they paid. Accordingly, GE wasn’t concerned with how much it paid for acquisitions.

There is another lesson here. Pay attention, CFOs: For an investor, simplicity and transparency from a company are what’s golden. If a company’s business is complex and opaque, an insightful investor will move on.

One of the most important things for investors is what they do after they buy a stock and before they sell it. After they buy, it’s just a matter of time before their initial assumptions come under fire. Maintaining rationality throughout their ownership of the company is paramount, and to do that they need to understand the business well. That’s why I have no opinion on General Electric shares now.

Once in a while, after my firm has done extensive research on a business we understand, I may have an opinion that runs contrary to the market’s. In those few situations you can drive a truck between the stock price and what we believe the company’s value is. That’s when we dig in and become contrarian-driven buyers.

Skilled investors never make a decision based solely on someone else’s research; they use it as a starting point for your own investigation. And keep in mind that any media reports, or even sophisticated brokerage research, about a company are just snapshots of the moment. If the facts change, investors can and will change their minds.

Vitaliy Katsenelson is CEO of Investment Management Associates, which is anything but your average investment firm. (Seriously — take a look.)

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