At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Out with GE, in with 3M
Bad news for General Electric (NYSE: GE ) investors is good news for 3M (NYSE: MMM ) shareholders this week, as investment megabanker Morgan Stanley shifts its bets in the large-cap conglomerate space. StreetInsider.com is reporting that MS cut its rating on GE to "equalweight" yesterday, citing "rising delinquencies in the EU" that could pressure GE's financial division (which accounts for 31% of annual revenues). The analyst also warns that GE faces "tough comps in Energy and Aviation" (30% and 13% of revenues, respectively), and could suffer margin erosion in both these businesses.
Coincidentally, GE helped to address at least some of these concerns yesterday, when it announced a deal to provide Boeing (NYSE: BA ) up to $180 million worth of mission control systems for the plane maker's new KC-46A refueling tanker. But regardless, with the stock up 8% since its lows of early June, MS seems to think discretion is the better part of valor here. It's recommending that investors take their short-term GE winnings, and invest them instead in shares of 3M, which have been lagging the S&P 500 all year long.
But does this really make sense?
One word: No.
Not really, no, it doesn't. While it's true that on the surface, 3M looks a little cheaper than GE -- 14.5 times earnings versus the 16.2 P/E at GE -- there's good reason for a share of GE to cost a bit more than a share of 3M. For one thing, it comes with a bigger dividend yield of 3.4%, versus the 2.7% payout at 3M. For another, GE is growing faster than 3M. On average, Wall Street analysts expect to see GE grow its earnings at close to 13% per year over the next five years. 3M, in contrast, will be lucky to break above 10%.
And of course, there's the question of the quality of these profits. In the case of General Electric, firmwide free cash flow for the past 12 months approached $20 billion, or 40% better than what GE was permitted to claim as its "net income" under GAAP accounting rules. In contrast, 3M generated less than $4 billion in cash over the past year -- nearly 8% less than its reported net income.
Getting better and better
GE could even be cheaper than that. Next week, analysts expect GE to report second-quarter profits nearly flat against last year's earnings. But thanks to share buybacks, the per-share profit GE reports will be closer to 6% improved over last year. As one analyst recently noted, while viewed in isolation these numbers aren't particularly impressive, if GE delivers the numbers it's expected to, it will be expanding profits at roughly four times the rate of U.S. GDP expansion (1.5%).
That's not half bad performance in a weak economy, and augurs well for even better profits when business begins to improve in future years.
When you get right down to it, I suppose I understand why in a market as uncertain as this one, Morgan Stanley might be inclined to covet any winnings it's managed to accrue, and jealously guard them. I'm not sure why it might want to take its GE profits and roll them over into a stock that's not performed quite as well. If that's your strategy, though, then there are far better places to put your money than 3M.
United Technologies (NYSE: UTX ) , for example. It's a blue chip, large-cap conglomerate (check). It's lagged the S&P 500 considerably over the past year (check). And with a 12% growth rate, and a 2.9% dividend, it's both faster growing and more dividend-generous than 3M (check and double check), with a P/E ratio that's right there in between what GE costs, and what 3M costs.
Want more growth, and not afraid to pay up for it? According to Yahoo! Finance, rival industrialist Textron (NYSE: TXT ) is slated for 30%-plus earnings growth over the next five years. It costs a bit more -- 21 times earnings -- and doesn't pay much of a dividend. But from a pure PEG valuation perspective, it's still a better bargain than 3M.
For that matter, even Boeing -- already mentioned above -- looks more promising than 3M. The P/E at Boeing is nearly a full point lower than what 3M costs, while the dividend yield is almost identical. Topping it all off, Boeing shows a growth rate close to what you'll find at UTC or GE. By any measure, it's a better bargain than 3M, and a better candidate for rolling over your GE profits than what Morgan Stanley is recommending.
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