When General Electric (NYSE:GE) reported 19% year-over-year growth in orders on Friday, the market swooned. After announcing earnings, GE's stock gained 7% in two days, as investors were reassured by the industrial giant's outlook.
The swelling backlog indicated the industrial giant was once again on solid footing, particularly in the U.S. market. But GE's $229 billion backlog didn't emerge overnight. Instead, GE's recent strength springs from a half-decade of refocusing and rebuilding a world-class manufacturing company. At this point, should investors consider building their portfolio around this American icon? Let's take a closer look.
What's boosting GE's backlog
In the most recent third quarter, GE failed to beat analysts' expectations on both the top and bottom line. Revenue fell short by nearly 1%, and earnings per share merely met expectations of $0.36, yet the stock surged following the announcement. What gives?
For once it seems the market was less concerned about quarterly earnings (which my colleague David Hanson poignantly says are utterly useless) and more concerned about the state of the business. And, with that forward-looking perspective in mind, GE provided reasons to be bullish.
GE breaks out its industrial business -- everything outside of GE Capital -- into six different segments today, and every single segment showed positive growth in equipment orders during the third quarter. When it came to services orders, five out of the six segments posted positive gains versus last year. Thus, a 32% year-over-year growth in equipment and 5% growth in services resulted in the 19% backlog increase. In an economic environment constantly in flux -- one that CEO Jeff Immelt refers to as the "new normal" state of volatility -- that's a reassuring sign.
Why the backlog really matters
A steadily climbing backlog in GE's industrial segments bodes well for the future for a couple of reasons.
On one hand, GE is a massive company that spans across many different industries. Similar to its industrial peers such as Boeing, Honeywell, and Caterpillar, GE's fate is linked to consistently expanding economies around the world.
Yet in recent years, Immelt's aimed to decouple the company's performance from lackluster economic growth. While GE still has its fingers in many different pies, the company looks less like a diversified conglomerate and more like a focused industrial enterprise every year. The recent spin-off of NBC Universal is a testament to this strategy of pruning GE's portfolio.
As GE shifts away from a motley collection of unrelated businesses, it aims to invest in products that will be in high demand for decades to come, including energy, transportation, and health care. Resounding growth in these areas, as illustrated in the most recent quarter, will buffer GE from the ebbs and flows of increasingly cyclical economies.
Taken a step further, an emphasis on industrial operations separates the fate of GE from its banking arm, GE Capital. While GE Capital accounted for 29% of revenue in the recent quarter, that's down from 31% at 2012 year-end and part of an ongoing decline I highlighted in a recent article. Earnings from GE Capital have also diminished as a percentage of overall net income.
In short, this most recent quarter was not unlike the rather ho-hum earnings reports of late for GE, with one notable exception: GE's growing backlog revealed strength in the industrial businesses that really matter for its future. Management continues to chip away at GE Capital's heft, and the market appears more confident that industrial operations will drive GE forward.
What the future holds for GE
While the company's overhaul has been akin to an 18-wheeler making a sharp turn, GE appears to be finally rounding the corner. Shareholders over the past three years watched their stock climb more than 60%, and the future seems to hold even more promise given GE's bulging backlog. GE Capital will gradually return to an old-fashioned (see boring) banking business, but innovative technologies such as the industrial Internet, 3-D printing, and alternative energy will pave the way going forward. At this point, investors might want to hop on for the ride.