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Valuing GE Stock: Behind The Headlines And Past The Dow

Valuing GE Stock: Behind The Headlines And Past The Dow

General Electric Company (NYSE: GE) has been dominating the headlines lately amid a call to put an end to the dividend it has paid for nearly 120 years. GE stock has plunged more than 50 percent over the last year, and as a result, it was ejected from the Dow Jones Industrial Average after more than a century as a staple of the index.

The rapid decline in GE shares and the negative news flow have triggered a hearty debate about the company's worth. Arguments about fundamentals seem to be buried under concerns about the company's balance sheet and questionable accounting practices.

Accounting Problems At General Electric

Over the last couple of years, more and more attention is being paid to accounting practices, so it's no surprise that GE's irregularities have finally moved centerstage. The Securities and Exchange Commission has been flagging the use of non-GAAP numbers more and more over the last couple of years, noting that companies which favor non-GAAP methods typically do it so they can make their fundamentals look better than they actually are.

The SEC released new guidelines on Generally Accepted Accounting Practices about two years ago. Those guidelines mandated that companies make their earnings releases explicitly clear, to explain any non-GAAP numbers clearly, and to display GAAP numbers with "equal or greater prominence" than non-GAAP numbers. Despite those guidelines, many companies continue to find ways to mislead investors, and GE has been among them for many years.

For example, General Electric had been displaying as many as four different numbers for earnings per share on its releases and making it difficult to discern what the real number should be. CEO John Flannery pledged toward the end of last year to improve transparency in the company's reporting, and while some progress has been made in terms how the appearance of the release itself, there's still plenty of room for improvement. Clearly, not enough progress has been made because investors still seem unsure of just how well GE is doing fundamentally.

GE May Stop Being A Dividend Stock

More recently, investors have become concerned about the company's dividend since Goldman Sachs analysts suggested that it should stop paying the dividend for about 18 months. They noted that the company could save $6 billion by suspending its dividend and then use those funds to deal with its biggest problems: its huge piles of debt and massive pension shortfall.

The industrial giant has been paying dividends for the last 119 years, even during the Great Depression and the 2008 financial crisis, so it has long been a staple for investors who favor dividend stocks. But what if GE stops being a dividend stock? That would certainly have an impact on the company's valuation, and that impact isn't factored in by just looking at fundamentals. Not everyone is convinced that General Electric will suspend its dividend, and while GE management has decided to pay the for at least one more quarter, it's easy to see why the issue is still a concern.

Wellington Management conducted an analysis of dividend stocks dating back to the Great Depression and found that high-yield stocks tend to outperform the S&P. While GE's payout ratio, at around 5 percent, isn't exactly high-flying, it has been enough to attract dividend investors because of the company's historical blue-chip status.

GE Agrees To Sell Gas-Engine Business

Although they haven't eliminated the dividend yet, GE management is trying to attack the company's debt problem in other ways, however. Data from Moody's indicates that General Electric has almost tripled its total debt over the last five years, bringing the total to $77 billion, including the pension shortfall, which is the biggest in the S&P 500.

At this point, the industrial giant is trying to attack its debt problems through asset sales. GE said in a statement today that Advent International has agreed to pay $3.25 billion for its industrial gas-engine business. Included in the deal are the Waukesha and Jenbacher engine brands and manufacturing facilities in the U.S., Canada and Austria.

The deal with Advent follows the sale of its railroad business to Wabtech, and more asset sales are expected in the near future. GE is also trying to sell its light bulb business, but it has found no takers since it started searching for a buyer almost a year ago. That's certainly not a good sign.

What Is GE Stock Really Worth?

So with all these problems weighing on GE stock, analysts are now debating what it's worth. GE has been a trusted name for more than a century, both among consumers and investors, but all the concerns about the company's accounting practices have severely dented its reputation. Still, based on fundamentals, consensus estimates, adjusted book value and discounted cash flow, StockCalc pegs the value of GE stock at $14.73 per share, which would make it undervalued by approximately 15 percent. However, that doesn't take into account the negative headlines that have slammed the company for the last several months.

Being removed from the Dow Jones was another major blow that isn't included in fundamental estimates, but history suggests that this could turn out to be a good thing. Wharton University professor Jeremy Siegel conducted a study on stock returns for companies added and removed from the S&P 500 going all the way back to the 1950s. He found that, based on averages, companies that were removed from the index outperformed those that were added. In the case of GE stock though, the other extenuating circumstances could place it in the minority on this factor.

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