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Falling Knives
General Electric Obscenely Cheap?

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By mungofitch
April 3, 2009

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General Electric is obscenely cheap right now, at $10.09. For the current price of around $10 to be reasonable, the financial side of the firm would have to be worth negative $100 billion or so in order to erase the undisputed huge value of the industrial side. But, alas, there is a faint possibility that this is the case, which is why nobody is going in with both feet.

So, here's a thought: $20 calls expiring January 2011 (1.8 years from now) have an asking price of 94 cents right now. By then it's likely that the time bomb will have gone off if it exists. So, if there is nothing left but debris, you've lost $1, and if the value is real it's worth hugely more than $20.94 (your net entry cost per share) and will probably be trading well above that. Losing $1 is better than losing $10.08. Yes, you're giving up a lot of up side, but there is so much up side if nothing blows up that it might not matter.

Personally I think the most likely outcome is that they will not only survive but prosper, and that the dividend will be reinstated within 2-4 years at its previous level. That would be a 5.9% yield on the effective entry cost of this gamble. Obviously the most likely outcome is by no means the only possible outcome.

The $15 calls are available for $1.86, so the net entry cost is $16.86 and the old dividend if reinstated would be a 7.35% yield on your $16.86 net entry cost if you exercise the calls.

Why all this dividend talk? I'm not a big fan of dividends for a variety of reasons. They are not income, they are just a way of receiving income. However, I mention those yields because they give a sense of scale: there is no such thing as a sustainably high dividend yield. Either the dividend gets cut, or the stock price rises. I think the latter is what will happen when things look rosier and the dividend is restored.

Just a thought. Normally I don't like OTM calls much, but the asymmetry of outcomes of the options seems to match the asymmetry of the probability of outcomes for the company. Even though the premia are high right now, it would be nice to be the one with the power to decide after seeing what the next two years bring.

In short, depending on the options you choose, IMO it's a $10-25 up side with high probability and a $1-$2 down side with lower probability, and a time to completion of 1-6 years, most likely 2-3. For whatever it's worth (not too much), Value Line forecasts a price in the $45-$60 range in the 2011-2013 time frame. That would put the up side at $24-$43 in 2-4 years depending on which options you pick how long it takes, and which price it hits, with the same $1-$2 down side.

The final outcome (neither recovery nor blowup) is actually fairly unlikely in my view--i.e., the company stays solid but continues to trade below the option strike price. Add that to the down side pile. Unless the list of down side outcomes makes a pile five times as big as the up side pile, it might be a good bet.

Jim