Owners of General Electric (NYSE:GE) stock can be forgiven for thinking the company has already had its bounce. After all, the stock is up 83% in the last three months. However, it's worth noting that it's still down 3% over the last year. As such, there may well be a case for the stock to appreciate strongly in 2021 as well.

Let's take a look at this industrial giant and see what GE needs to do to have a great 2021.

The investment thesis

The case for buying GE stock is simple to understand, but complex to evaluate. It's based on the idea that GE's free cash flow (FCF) is set to mark a multi-year recovery. For reference, FCF is simply the flow of cash in a year that a company has free in order to pay back debt, make share buybacks, and/or pay dividends to investors.

The bulls are expecting all four of GE's industrial segments to improve FCF in the future. The company's key segment, GE Aviation, is expected to make a multi-year recovery from a calamitous 2020 when the coronavirus pandemic spread out of China and wrought devastation on the global air transport industry.

An aircraft engine.

Image source: Getty Images.

Meanwhile, GE Health Care is expected to carry on churning out low-to mid-single-digit growth and $1 billion-plus in FCF. On the industrial side, the other two segments, power and renewable energy, are expected to carry on down a pathway leading to becoming FCF generators again, with earnings margins comparable to their peers.

Turning away from the industrial businesses and moving to the finance arm, GE Capital, the main hope is that a recovery in commercial aviation will help its aircraft leasing business, GE Capital Aviation Services or GECAS. 

When you put it all together, the case for GE is based on analysts projecting an improvement in FCF in the future and then using that to produce a valuation target for the company. One way to do that is by looking at the company's price-to-FCF multiple. As a rough rule of thumb, a price-to-FCF multiple of around 20 times could be seen as a fair value for a company growing earnings in a mid-single-digit percentage.

General Electric's valuation, or valuations

Unfortunately, it's fair to say that GE's recent earnings and FCF generation have been patchy at best in the last few years, and there are a lot of variables to be factored into its recovery. That's a fact reflected in what Wall Street analysts are projecting for its FCF in the future.

Two of the more bullish analysts on GE, namely Barclay's Julian Mitchell and Bank of America's Andrew Obin, are reportedly modeling $6 billion and $4.7 billion in FCF for GE in 2022. Meanwhile, the analyst consensus is $3.6 billion.

Purely as an example, and in order to flesh out what these numbers mean to GE's price-to-FCF valuation, here's a table that lays out the scenarios. Clearly, a FCF figure of $6 billion in 2020 would make GE look like a very good value stock. Meanwhile, the analyst consensus of $3.6 billion makes GE look slightly overvalued.

General Electric Free Cash Flow in 2022

Price-to-Free Cash Flow Multiple

At $3.6 billion

26.9 times

At $4.7 billion

20.7 times

At $6 billion

16 times

Data source: Author's analysis, marketscreener.com

How to interpret the valuations

The variance in analyst forecasts highlights the point that there is a lot of uncertainty around GE's earnings and FCF trajectory. This is understandable. After all, GE Aviation's earnings will be largely determined by how strongly commercial air travel comes back. In addition, there's no guarantee that GE's power and renewable energy segments will improve margins as expected.

As such, it's very difficult to put a fine point on GE's future FCF. Indeed, the consensus FCF forecast for 2022 has declined from the near $4 billion expected a few weeks ago

Clearly, there's a lot of uncertainty around GE's future earnings and FCF growth. That said, we do know that it's highly likely that GE's FCF will improve significantly. The healthcare business is a very solid performer. GE Aviation is the world's leading aircraft engine manufacturer, providing engines on both the Boeing 737 Max and the Airbus A320neo, and it has a significantly growing defense business too. The coronavirus vaccine will obviously boost prospects for air travel in 2021. Furthermore, GE is already making progress on power and renewable energy margins, and CEO Larry Culp has a very successful track record of improving businesses.

Wind turbines.

Image source: Getty Images.

Can General Electric stock bounce in 2021?

On balance, the answer is "yes," but investors will need to keep an eye out for improvements in commercial air travel and margins in power and renewable energy. Given that most observers don't expect the aviation industry to return to 2019 levels until 2023 or 2024, it means that GE will be in the middle of a multi-year recovery journey in 2022, so FCF is likely to improve markedly for a few years after that.

If that's too long to wait for investors, then the answer is to avoid the stock. However, if you think the vaccine will lead to a recovery in air traffic and you believe in Culp's ability to improve margins, then you will favor the more optimistic FCF estimates given above. In that case, GE remains a good value stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.