While working on our presentation analyzing the arguments of JP Morgan’s analyst regarding GE, I sent questions to the company’s Investor Relations team.
Last week, I sat down on several occasions to speak with the IR representative about my questions, which focused in on profit dynamics, especially on the structural capacity of the company to convert its revenues to profits.
Not only were these meetings helpful to me from the perspective of understanding GE’s profit structure, but also from the perspective of my approach to valuing GE in general. Long story short, I have decided that management’s encouragement to think of GE in terms of two separate entities – an Industrials entity and a Financing entity – is not always the most helpful approach. On one hand, the inclusion of two separate statements of cash flows is helpful in understanding dynamics of the financing business, in particular; on the other hand, the adjustments the firm makes to its cash flow numbers is confusing and the talk of Financing dividends paid to Industrials as part of Cash from Operations is, upon reflection, better thought of as part of the Industrial segment’s investing activities.
We have updated our model to reflect this conceptual change and have spelled out our more detailed thinking regarding likely profitability at the company.
Through all of this, our valuation range did not change. Our profitability assumptions are slightly lower in the very near term, but this negative is offset by a boost to FCFO in the current year that we realized would occur by taking a detailed look at asset dispositions and investment payouts.
That said, our perception of likely outcomes did change in the process of this more detailed review and we now find our best-case profitability scenarios less likely. This shifts down our perception of the most-likely value of the stock, and we have decided to dial back the leverage component of this investment.
It seems as though we are spending a lot of time and energy on General Electric, but this is, in fact, what happens in the real world of investing. Investments require relatively more or less time and energy depending on what is happening operationally at the firm. Hopefully, these notes on our valuation of GE will be helpful to your understanding of the firm.
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