*The 7E Gas Turbine: Image Courtesy of General Electric Corporation
For an investor focused on long-term outperformance, timing the market means nothing. It's time in the market that means everything. While Wall Street analysts remain oblivious to this critical ingredient for success, savvy investors can take advantage of their short-term bias. Shares of industrial giant General Electric (GE 3.94%) offer the latest opportunity to get right what Wall Street's getting all wrong.
Fears misplaced
On Jan. 3, analysts from investment firm Oppenheimer downgraded GE's stock to perform from outperform, citing the beginning of a "transitional" period that will deliver underwhelming earnings-per-share growth. Without any other GE stories on the radar to kick off the year, Oppenheimer's opinion seemed wholly responsible for the stock's subsequent 2.75% decline.
But the stock's brief dip shouldn't concern shareholders. After all, the champagne was probably still flowing as GE owners celebrated a 37% return in 2013, which bested the Dow Jones Industrial Average by 11%. The concerning -- or perhaps confusing -- aspects of the downgrade were its inherent contradictions, its blatant short-termism, and its place in a long line of negative analyst coverage for GE.
Oppenheimer's report, according to Barron's, claimed that GE's shift to industrial businesses, coupled with a downsizing of its banking unit GE Capital, left little room for growth in earnings. In other words, GE put its banking business on the back burner, so Oppenheimer felt inclined to do the same to GE's stock.
But fears of a shrinking GE Capital seem misplaced or, at least, untimely. During the past few years, GE Capital's asset base has declined quite steadily, while the company's made progress in recovering from the banking crisis. This is an old story and, in spite of a downward revenue trend, GE Capital has actually packed more punch on the bottom line. So shareholders like myself are left wondering, "Why now?"
A chink in the argument
Oppenheimer analysts seem to believe that the divestment of GE Capital's consumer finance business -- announced in November -- tilted the balance. From their perspective, GE is now embarking on a two-year transitional phase that will produce lackluster single-digit earnings growth. The consequences? An underperforming stock, in analysts' eyes.
Now, these sentiments might be easy to reconcile if it weren't for a few key observations.
First off, Oppenheimer's report -- again according to Barron's -- proceeds to contradict itself in describing the outlook for General Electric, at least over a longer time horizon:
We continue to view shares as a solid store of value, with the 3.2% dividend yield, a case for solid industrial organic growth drivers, and understated 2014 earnings power given about $1B pre-tax net restructuring (~7c) included in our estimates...
So, the shares that have just been downgraded remain a solid income-generating investment with a promising growth outlook? Call me crazy, but that sounds exactly like a place where I want to put my money! What's more, GE's soaring industrial backlog takes some of the risk and economic uncertainty out of the picture.
What this highlights, more than anything, is the complexity of Wall Street's rating machine. If there's a case to be made for a better investment opportunity, make it. But, quite frankly, who even knows what perform means? If an NFL analyst says my team will play on Sunday, does that mean they're going to win or lose? I'm not really sure.
Second, GE's downgrade seems to indicate that the stock's going nowhere in the next year or two. Or perhaps Oppenheimer expects it to match the market, and no more. Either way, does this tell investors that GE will not beat the market three, four, or even five years out? And shouldn't that time frame matter more?
As the Fool's co-founder, Tom Gardner, is prone to point out, "Far more money will be made by disciplining ourselves to look for long-term winners and then letting these winners run than would ever be saved by trying to pick the right exit points along the way."
Tom holds stocks in his Everlasting Portfolio for no less than five years, and I tend to agree with his approach. So if GE's been a winner in investors' portfolios over the past couple of years, should they head for the exits, or double down on a great business? The latter seems to make more sense.
Finally, General Electric's ratings coverage by various Wall Street shops has proven abysmal in the recent past, but maybe that shouldn't come as a surprise. Out of nine ratings calls made in two years, only two shops have labeled GE a buy; the rest were either a sell, or a neutral equivalent. In that time frame, the stock's climbed 53%, beating the Dow by 18 percentage points.
My personal favorite rating came in April, when JPMorgan informed clients that GE's stock was "dead money near term." Shares could no longer be considered a "safety stock" in their view. As a result, GE's stock tumbled about 5% in a week, only to recover by 29% by year's end. So much for "dead money."
The perils of forecasting
While it's hard to blame an analyst -- or anyone, for that matter -- for missing a short-term forecast, it's easy to blame someone for making that bad call in the first place. With a diverse, international company like General Electric, I find it hard to believe that even the CEO could accurately predict where the business is headed a year out. Too many variables are in play. In fact, I commented on management's dramatic about-face in an article last year.
For Foolish investors, the game of forecasting might as well not exist. In fact, our job is really quite simple: Ignore the noise, revisit the original rationale for buying the stock, and assess the business as it stands. If you liked GE's business a year ago due to its climbing backlog, investments in 3-D manufacturing, and rollout of the industrial Internet, then it's hard to imagine why you wouldn't still like it today.
When our long-term time horizon presents an opportunity to take advantage of the market's short-termism, we here at the Fool call it time arbitrage. So the next time a Wall Street analyst sends shares of a strong business tumbling, grab your fork and knife. Whoever said there's no such thing as a free lunch?
