Digital Initiatives Will Continue To Drive GE Stock

  • General Electric is well positioned to achieve significant growth due to its digital initiatives.
  • GE's decision to restructure the company focusing on its industrial group has been a smart move.
  • GE generates strong cash flow and returns substantial capital to its shareholders through stock buybacks and increasing dividend payments.

General Electric (NYSE:GE) stock has soared 7.4% in a month and 24.7% in a year, reaching its highest value since May 2008. As such, some investors might consider GE's stock too expensive taking into account the standard parameters like P/E, price to sales and price to book value ratios which seem to be too high right now. However, in my opinion, General Electric is well positioned to obtain significant growth due to the recent developments in its business, and its stock is still a sound investment.

GE Stock Weekly Chart

2016-07-19 06_56_23-GE 18-7-16 - Microsoft Word -22

Chart: TradeStation Group, Inc.

On July 11, 2016, GE and Microsoft (NSDQ:MSFT) announced a partnership that will make GE’s Predix platform for the Industrial Internet available on Microsoft Azure cloud for industrial businesses. In the announcement, GE said:

"The move marks the first step in a broad strategic collaboration between the two companies, which will allow customers around the world to capture intelligence from their industrial assets and take advantage of Microsoft’s enterprise cloud applications."

According to Gartner, 6.4 billion connected things are expected to be in use worldwide in 2016, up 30% from 2015, and will reach 20.8 billion by 2020. In 2016, 5.5 million new things will get connected every day.

In my view, GE's digital initiatives will be significant growth drivers for the company. According to GE, connecting industrial machines to the internet through the cloud is a huge step toward simplifying business processes and reimagining how work gets done. GE has also developed an operating system called the Predix that offers a cloud-based platform for running these applications. GE digital business achieved revenues of $5 billion in 2015, and it expects revenues of $6 billion in 2016 and hopes to achieve revenues of $15 billion by 2020. As GE is a pioneer in this area, I believe it would give the company a significant advantage in the coming years.

As I see it, GE's decision to restructure the company focusing on its industrial group has been a smart move, making the company easier to manage, and concentrating on activities with higher growth prospects. Also, the management has been keeping its focus on controlling costs, and as a result, its Industrial segment operating margin rose 30 basis points in the last quarter to 12.8%. The company has significantly reduced its financial service and closed, last month, the sale of its appliances business to the Chinese multinational consumer electronics, Haier, for $5.4 billion.

GE started to reduce the size of the financial business after the financial crisis of 2008-2009, as the wholesale funding market disappeared, driving down returns on the financial business. In November 2015, GE closed the acquisition of the power and grid business of the French company Alstom S.A. for $9.5 billion in cash. Alstom deal will strengthen GE's position in wind energy and grid management, and increase the company's revenue from international markets.

Backlog

GE has a strong backlog, and its backlog has continued to grow. At the end of the first quarter of 2016, the company's backlog was $316 billion, up 18% from the same quarter a year ago. The aviation segment had the highest backlog $153.4 billion, up 9% year-over-year. The power segment had a backlog of $77.8 billion, of which $15.2 billion came from Alstom. The core power backlog of $62.6 billion was higher by 11% from the same quarter last year.

Valuation

Since the beginning of the year, GE's stock is up 5.7% while the S&P 500 Index has increased 6.0%, and the Nasdaq Composite Index has gained 1.0%. Since the beginning of 2012, GE's stock has gained 83.8%. In this period, the S&P 500 Index has increased 72.3%, and the Nasdaq Composite Index has risen 94.1%.

According to its valuation metrics, GE's stock is not cheap. However, its average annual estimated EPS growth for the next five years is high at 12.7%. The trailing P/E is at 44.6, and the forward P/E is at 18.9. The price to sales is at 2.57, and the price to book value is at 3.32. Furthermore, the price to cash flow ratio is at 18.1, the Enterprise Value/EBITDA ratio is at 31.1, and the PEG ratio at 1.73.

Dividend and Share Repurchase

General Electric had cut its dividend payment in the years 2009, 2010, as a result, of the 2008-2009 global financial crisis, but had started to increase its dividend payment again in 2011. GE said that it plans to maintain its dividend at the current level in 2016 and grow it after that. The current annual dividend yield is at 2.80%, and the payout ratio is at 137%. However, the dividend coverage ratio which excludes extraordinary items is at 72.9%. The annual rate of dividend growth over the past three years was high at 9.5%, and over the past five years was very high at 14.9%. GE's board has authorized a repurchase program of up to $50 billion in common stock. The company targets returning $32 billion to shareholders between 2016 and 2018 through stock buybacks and increasing dividend payments.

Conclusion

In my opinion, General Electric is well positioned to obtain significant growth due to its digital initiatives. As I see it, GE's decision to restructure the company, focusing on its industrial group, has been a smart move, making the company easier to manage, and concentrating on activities with higher growth prospects. Despite pretty high valuation metrics, GE's stock is still attractive, and its average annual estimated EPS growth for the next five years is high. Moreover, the company generates strong cash flow and returns substantial capital to its shareholders through stock buyback and increasing dividend payments.

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  • I do not hold any positions in the stocks mentioned in this post and don't intend to initiate a position in the next 72 hours
  • I am not an investment advisor, and my opinion should not be treated as investment advice.
  • I am not being compensated for this post (except possibly by Amigobulls).
  • I do not have any business relationship with the companies mentioned in this post.
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