Numbers can lie -- but they're the best first step in determining whether a stock is a buy. In this series, we use some carefully chosen metrics to size up a stock's true value based on the following clues:
- The current price multiples
- The consistency of past earnings and cash flow
- How much growth we can expect
Let's see what those numbers can tell us about how cheap General Electric
The current price multiples
First, we'll look at most investors' favorite metric: the P/E ratio. It divides the company's share price by its earnings per share (EPS) -- the lower, the better.
Then, we'll take things up a notch with a more advanced metric: enterprise value to unlevered free cash flow. This divides the company's enterprise value (basically, its market cap plus its debt, minus its cash) by its unlevered free cash flow (its free cash flow, adding back the interest payments on its debt). Like the P/E, the lower this number is, the better.
Analysts argue about which is more important -- earnings or cash flow. Who cares? A good buy ideally has low multiples on both.
General Electric has a P/E ratio of 14.7 and an EV/FCF ratio of 19.9 over the trailing 12 months. If we stretch back and compare current valuations to the five-year averages for earnings and free cash flow, General Electric has a P/E ratio of 9.2 and a 5-year EV/FCF ratio of 24.0. For both metrics, we'd like to see a one-year ratio of less than 10; for a five-year ratio, we're shooting for less than 20.
General Electric has a mixed performance in hitting the ideal targets, but let's see how it compares against some competitors and industry mates.
To make comparison to some competitors a little bit easier, let's average General Electric's P/E and EV/FCF ratios.
|
Company |
Average 1-Year Multiples |
Average 5-Year Multiples |
|---|---|---|
|
General Electric |
17.3 |
16.6 |
|
3M |
14.0 |
16.7 |
|
Emerson Electric |
15.3 |
16.4 |
|
Honeywell International |
11.4 |
12.2 |
|
Average of Peers |
13.6 |
15.1 |
Source: Capital IQ, a division of Standard & Poor's.
General Electric looks expensive on both a one-year and five-year basis relative to its peers.
Numerically, we've seen how cheap General Electric is on both an absolute and relative basis. Next, let's examine...
The consistency of past earnings and cash flow
An ideal company will be steady (and growing) in its earnings and cash flow generation.
In the past five years, General Electric's net income margin has ranged from 6.9% to 13.3%. In that same time frame, unlevered free cash flow margin has ranged from 12.6% to 19.1%.
How do those figures compare with those of the company's peers? See for yourself:
Source: Capital IQ, a division of Standard & Poor's; margin ranges are combined.
Additionally, over the past five years, General Electric has tallied up 5 years of positive earnings and 5 years of positive free cash flow.
Next, let's figure out...
How much growth we can expect
Five-year analyst growth estimates tend to be comically overstated. If you accept them at face value, you will overpay for stocks. But while you should definitely take the analysts' prognostications with a grain of salt, they can still provide a useful ballpark estimate when compared to similar numbers from a company's closest rivals.
Let's start by seeing what this company's done over the past five years. In that time period, General Electric has put up past EPS growth rates of -9.4%. Meanwhile, Wall Street's analysts expect future growth rates of 10.5%.
Here's how General Electric compares it its peers for trailing five-year growth:
Source: Capital IQ, a division of Standard & Poor's; EPS growth shown.
And here's how it measures up with regard to the growth analysts expect over the next five years:
Source: Capital IQ, a division of Standard & Poor's; estimates for EPS growth.
The bottom line
The pile of numbers we've plowed through has shown us how cheap shares of General Electric are trading, how consistent its performance has been, and what kind of growth profile it has -- both on an absolute and a relative basis.
The more consistent a company's performance has been and the more growth we can expect, the more we should be willing to pay. We've gone well beyond looking at its 14.7 P/E ratio. Still, the numbers are just a start.
If you find General Electric's numbers compelling, continue your due diligence via earnings releases, 10-K's, company websites, Motley Fool CAPS, and more. You can also come back to Fool.com to see the analysis we're doing each day.
When you're finally confident that the numbers aren't lying to you, you'll be ready to make your own buy, sell, or hold call.
