Motley Fool Rule Breakers is an investing newsletter that focuses on "high-growth businesses poised to be tomorrow's market leaders." Led by The Motley Fool's co-founder and "Chief Rule Breaker" David Gardner, the newsletter often invests in companies that are in their early growth stages. The ultimate goal of Rule Breakers is to find companies that will keep succeeding in the future, and turn handsome profits for investors.
In practice, "Rule Breaker" investments have proven to be a diverse set of companies that cover a wide range of industries, market capitalizations, and maturity levels. Consequently, the universe is unified by the selection process through a lens of six specific criteria -- a lens that has helped Rule Breakers nearly double the S&P 500's return since its inception in 2004.
Surprisingly, running General Electric (NYSE:GE) through the Rule Breaker selection process yields an unexpected result. The industrial giant shares many of the same traits of a potential Rule Breaker.
1. Top dog and first mover in an important, emerging industry
Whether it's disruptive technology, a new business model, or unparalleled expertise, Rule Breakers tend to be leaders of their industry in some fashion.
Although many of the areas that General Electric competes in aren't considered emerging, the company is often viewed as holding a competitive advantage in the marketplace -- thanks to its deep domain expertise of industrial processes that it often cross-leverages so that it can gain an advantage.
GE is also the top dog in a promising emerging industry known as the Industrial Internet -- the Internet of Things for industrial applications like manufacturing, power generation, and oil and gas. This burgeoning industry promises to deliver a significant leap in global industrial productivity by marrying physical industrial assets with sensors connected to the Internet, sophisticated software, and complex predictive analytics. The stakes are quite high: An increase of 1% to 1.5% in annual U.S. industrial productivity and half of that worldwide is estimated to add between $10 trillion to $15 trillion in global GDP during the next 15 to 20 years.
Asserting its leadership in the Industrial Internet, General Electric recently launched the world's first "App Store" for industrial operators to develop apps that can significantly improve their productivity. The company hopes it will catalyze a $225 billion industrial app revolution, similar to the consumer app revolution that smartphones created.
2. Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors
To put it simply: what's GE's "moat" against competitors?
For one, the barrier of entry to build industrial products like jet engines, locomotives, gas turbines, and advanced turbomachinery, is prohibitively high. Not only does it require significant capital spending, but it also requires demanding expertise in areas like engineering, physics, and chemistry.
When it comes to building digital platforms on top of industrial operations, few companies in the world posses GE's deep industrial domain and technological expertise to unlock real-time insights that lead to improved productivity. Here are some examples how this combined expertise can add value to industry:
3. Strong past price appreciation
On a high level, the best growth stocks continue to rise because their competitive advantages help drive long-term earnings and cash-flow growth. Unfortunately, as the following chart illustrates, GE's 10-year stock performance falls woefully short on this metric. Clearly, the burden of operating a massive financial services business during the largest financial crisis since The Great Depression has weighed heavily on shares.
4. Good management and smart backing
Without the right leadership in place, it's difficult for companies to perform at their best. Although CEO Jeff Immelt isn't fully appreciated by investors due to the stock's weak performance during his tenure, GE's top chief commands an 84% approval rating on employer review site Glassdoor from nearly 1,400 reviews.
In April, Immelt took tremendous measures to return GE to its industrial roots when it announced that the company would become a more focused industrial company by selling off the majority of its GE Capital business. The initiative has promised investors that 90% of its earnings will come from industrial activities by the end of 2018. At close of the third quarter, GE has already signed nearly $95 billion of GE Capital deals that reduces its financial services footprint.
5. Strong consumer appeal
The value of a strong brand is a tremendous asset in the marketplace. It helps companies build solid reputations that can reinforce and sustain growth.
Since its founding in 1892, GE has done a tremendous job building a top-10 global brand. According to Forbes' The World's Most Valuable Brands list, GE ranked ninth in the world in May. Interbrand, a leading global brand consulting firm, ranks GE's brand as the eighth most valuable in the world, carrying a value of nearly $42.3 billion in 2015.
6. Grossly overvalued according the financial media
Rule Breakers relishes when a candidate's stock is considered grossly overvalued by the media. The newsletter believes "the 'too expensive' label comes from underestimating how a Rule Breaker can disrupt its industry, displace competitors, and grow over a relatively short time."
With the S&P 500 trading at 20.3 times trailing earnings and GE trading at 18.2 times its 2016 earnings estimates, the company doesn't even come close to being grossly overvalued by the financial media. Given its massive size, it also may not be appropriate to argue that GE will grow rapidly over a short period of time.
Putting it all together
To be clear, not every Rule Breaker investment carries all six of these traits, and having Rule Breaker qualities doesn't guarantee that a stock will go on to produce market-beating returns over the long haul.
Overall, GE meets four of the six criteria that goes into making a stock a Rule Breaker. It's a top dog in industries where it competes, both new and emerging; its industrial domain expertise often gives it an advantage over its peers; its management team is highly endorsed by its employees; and it has a rock-solid brand.
Where GE falls short of being a complete Rule Breaker is the stock's poor past performance and its current valuation. The other overhang, which shouldn't be taken lightly, is its massive size that could prohibit its growth.
Ultimately, GE is commonly viewed as a company that's grown too big to produce meaningful returns. Perhaps its Rule-Breaking qualities aren't being fully appreciated by investors?