Earnings season is picking up steam, and the expectations game has commenced. For some companies, like Bank of America, the bar was relatively low, so investors cheered a surprise beat. For others, like General Electric (NYSE:GE), a similar feat will prove more difficult.
GE enters the ring following a stellar 2013 for the stock with a great deal of fanfare. Regardless, Friday's announcement will speak volumes about the company's current momentum, the validity of a recent downgrade, and where opportunities lie ahead for investors.
Tune out the noise
Whether it was GE's own predictions in December, the media's echo chamber, or Jim Cramer's recent bullishness on the stock, a high bar has been set for this industrial giant. And, frankly, that seems to suit GE just fine.
Over the past year, most manufacturing stocks have been plagued by earnings due to the constant comments about an economy teetering on a cliff. Meanwhile, the American economy's chugged along, and even Europe -- which cast a cloud over GE in early 2013 -- seems to be turning a corner. All the while, the average diversified industrial stock returned 43% in 2013. Not too shabby.
But concerns about the economy still exist. Investors are debating the impact of "tapering", and a declining employment figure can be chalked up to less available workers. So, in my opinion, the changing sentiment must be driven by strong business fundamentals at companies like GE. In other words, the stock market and media are now focusing on the underlying drivers of a business! Imagine that.
At the Motley Fool, we call that a "good start." Now, let's look at what investors should pay attention to on Friday.
Focus on the nuts and bolts
Last year, GE wrapped up a solid 2012 with notable improvements in three categories: growth, profit margins, and cash management. Since the storyline at GE remains the same -- downsizing GE Capital, jump-starting industrial businesses, and returning cash to shareholders -- there's no reason to change our focus this time around. That being said, here are the key metrics as GE closes the curtain on 2013:
Growth: Wall Street analysts are predicting $0.53 per share in fourth-quarter net income, which amounts to 20% growth year over year. While that sounds substantial, GE has a few things going for it. First off, the company defied expectations and beat earnings-per-share targets each of the last four quarters, albeit by small margins. Now, past performance doesn't guarantee future results, but GE's management team seemed optimistic after the third quarter. Commenting on double-digit-earnings gains on the industrial side, Immelt noted, "[We] expect a stronger fourth quarter in that regard." Further, the company expects organic growth to accelerate in the year ahead, so the wind is blowing in the right direction. Expect revenue growth in 2013 to be modest -- around 2% -- but earnings to be quite robust.
Profit margins: Stock price appreciation can come from two sources -- an increasing price multiple (less ideal for investors) or earnings growth (more ideal). Earnings growth can be driven by climbing revenue or margin expansion. While either method of growth is attractive to investors, GE has lagged when it comes to revenue due to a shrinking GE Capital unit. So, for 2013, investors should fixate on profit margin increases, which are expected to grow 0.7 percentage points to 15.3%. GE's cost-cutting programs will help deliver future expansion, and Immelt has set a margin target of 17% for 2016. As of the last quarter, GE seems on track in this department.
Cash and dividends: There are few companies that compare to GE when it comes to cash. Even management remarked on the "ton of cash" currently sitting on its balance sheet in December, $90 billion of which will be available over the next three years. The good news is GE has been putting that cash to work or shoveling it to investors. I would expect that to continue, as GE will look for opportunities for small, bolt-on acquisitions, or incrementally raise its dividend as it did a few weeks back. Management will likely remark on any new initiatives, but expect the dividend increases to continue. GE's latest was its sixth increase since the recession.
In my opinion, investors tuned into GE's progress over the past few years should not be disappointed on Friday. However, if growth in revenues, profitability, and dividends fail to surpass expectations, we'll look to understand whether this is a short-term hiccup or an underlying business problem. None of these can grow without signs of a strengthening market for GE's products or operational improvements.
For Fools who've held General Electric shares over the past five years, these positive trends have translated to handsome returns in excess of 95%. Ironically, plenty of other folks are just waking up to this great business.