In this video, I show how to use the online tools at IOITools.com to analyze the revenues and profitability of global industrial giant, General Electric. This video also shows how to calculate Owners' Cash Profit, or OCP, an owner-centric, cash-centric measure of profitability introduced in The Intelligent Option Investor: Applying Value Investing to the World of Options (2014, McGraw-Hill).
See also the replay of the YCharts conference call on GE as well as the YCharts Focus Report on GE, which you can find on the Resources tab of the YCharts site.
Here is a transcript of this video.
Welcome to the Intelligent Option Investor Video Series.
My name is Erik Kobayashi-Solomon, and I am the author of the Intelligent Option Investor.
Before we dig in, I want to make clear that this
presentation should in no way be considered an offer to buy or sell securities. Do be aware, though, that with regards to GE, I am talking
my own book.[1]
Today, I’m going to take you through an analysis of GE using
the online tools at IOITools.com.
This video uses only the first tool in the toolkit, the
Company Analyzer, and the Company Analyzer is set up to hone in on the three
most important valuation drivers
- Revenue Growth
- Profitability
- Investment Level & Efficacy
I've split the analysis video into two parts—in the part you’re
watching, I’ll only go through revenues and profitability. I’ll cover investment
level, cash flow, and investment efficacy in the next video, then go on to
value the company, see what the option market is saying, and look at different investment
structures in videos that follow.
Some tools in the IOI toolkit are meant to give you some
sort of answer. The Company analyzer is meant to tell you the right questions
to ask. I’ll show you what I mean as we go through.
Let’s get started!
Here we are at IOI Tools.com. To get to the Company Analyzer,
we just go to the Basic Toolkit and select the first menu item.
Once the Company Analyzer loads, it’s best to go down to the
Reset button and hit that. If you are using it a lot, sometimes old values get
cached in the browser and the calculations can get thrown off.
Revenues
The first thing to analyze is revenues.
As we can see here, revenues at GE fell from 182.5 billion
in 2008 to around 146 billion in the last fiscal year. This represents a 5-year
Compound annual growth rate of -4%, and of course the worst drop occurred in
the midst of the financial crisis—2009.
I graphed these numbers and a few other revenue numbers and
posted them at this link. Here’s what that graph looks like.
Dollar values are shown by blue columns and scaled on the
left. Year-over-year percentage change is shown by the black line and scaled on
the right.
Here we see the big drop in revenues from 2008-2009. This
black line shows is that revenues have flattened out over the past few years.
This is what I meant earlier when I said the Company
Analyzer wasn't meant to answer questions but show you the right questions to ask.
Looking at this graph, I was struck by the decline and started to ask why
revenues had flattened out—is demand weak for GE’s products and services?
What I found was that even though of the global recovery has
not been exactly robust a good bit of the weakness in GE’s revenue growth has
been due to the company divesting consumer facing businesses like NBC, credit
cards, and appliances.
I discuss this dynamic in great detail in a report I wrote
for YCharts and in a conference call I hosted about GE. You can find the report
and the replay of that conference call at ycharts.com/resources. If you don’t
see the GE Focus Report on that page, just click on the Focus Reports tab and
look for the report on GE.
Profitability
Now that we have an
idea about GE’s Revenues, let’s move to the next driver—profitability.
In the Intelligent Option Investor, I talk about an
owner-centric, cash-centric view of profitability that I call Owners' Cash
Profit or "OCP."
We calculate OCP by seeing how much cash flow from operations
the company reported, then estimating how much it costs to maintain the
business as a going concern.
Here are each of those line items here, and hovering over
this cell, you can see what figures I use to estimate how much maintenance
capex is needed.
We can see that OCP has fallen from around 37 billion in
2008 to around 19 billion in the most recent fiscal year—a CAGR of -13% over a
five year stretch.
Also, we can see that OCP margin looks as it is generally
somewhere in the mid-teens.
Again, there is a graph of GE’s profitability linked here,
so let’s take a look. Dollar values again are shown as blue columns and indexed
on the left. OCP margin—that is OCP as a percentage of revenues—is shown by the
black line and scaled on the right.
When I saw these figures and this graph, again, it brought
up questions rather than answers. Specifically, I wondered whether the company
was getting worse at generating profits or if profit levels would return to
some "average" level. The economic picture is very different if the profit margin is on a downward trajectory than if it is stable and will return toward its long-term mean.
The answer I got was that recent profitability weakness
probably has more to do with temporary issues related to corporate reshuffling—divestitures
and acquisitions—than it does to a structural weakness in GE’s ability to
convert revenues to profits.
GE operates in eight segments, and most of these segments
have very high profitability. There are two laggards—one of these, Appliances, is
being sold off, the other of these, Power Management, will become more
profitable due to the acquisition of French company Alstom. You can learn more
about this in the YCharts material I mentioned earlier.
Now that we have a good idea about how good GE is at turning
revenues into profits, we’ll look at how much of those profits it is spending
on growth investments in the next video in the series.
For now, let’s sum up what we’ve learned:
First, GE’s revenues have been declining over the past
several years. Some of this is due to economic weakness, but a
lot of it has to do with its divestment of its consumer facing business.
Profit levels have also been slipping, but again, this is mostly due to divestments. Fundamentally, GE’s businesses are all very
profitable and competitive—part of Jack Welch’s legacy. In the next video, I’ll show you why this
decreasing profit is not worrisome to me as an investor.
Last, for more detailed information about GE, please
take a look at my YCharts report on the company, which you can find at ycharts.com/resources.
Thanks
for joining me for this video, please continue on with me in this series!
Disclaimer
Intelligent Option Investor, LLC does not act in the
capacity of a Registered Investment Advisor. As such, all information provided
herein is for information purposes only and should not be considered as
investment advice or a recommendation to purchase or sell any specific
security. Security examples featured are samples for presentation purposes and are
intended to illustrate how to use methodology explained in The Intelligent
Option Investor: Applying Value Investing to the World of Options (2014,
McGraw-Hill) in the analysis of the valuation of public securities. While the
information presented herein is believed to be reliable, no representations or
warranty is made concerning the accuracy of any data presented.
This presentation is not intended as investment
advice, nor is it an offer to purchase or sell any specific security.
Disclosure
Mr. Kobayashi-Solomon initiated a beneficial ownership
position in the stock and options of General Electric IOI, LLC undertakes no
responsibility to update our clients regarding changes in the existence or size
of Mr. Kobayashi-Solomon’s investment position in General Electric’s stock or
options in the future.
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