Why Is General Electric Trading at a Premium?
Will Weak Macro Environment Affect General Electric in 1Q16?
Valuation of General Electric
Industrial companies’ performances are related to the performance of the macro economy. So you can say they’re cyclical in nature. When the economy is booming, these companies secure robust orders and execute them. Operating leverage comes into play, and their profits increase. This has a positive impact on EPS (earnings per share). Earnings are affected in a slow-growth, volatile environment.
So their earnings are good indicators of their business value. Industrial stocks are generally valued on the basis of their EPS.
Shares of General Electric (GE) currently trade at a PE (price-to-earnings) value of 26.0x. This isn’t cheap compared to GE’s peers and the industrial sector. The average PE multiple for industrial companies in XLI is 15.68x.
GE’s large-cap peers, 3M (MMM), Honeywell (HON), and Illinois Tool Works (ITW), are currently trading at PE multiples of 21.6x, 17.3x, and 20.7x, respectively.
But if you compare the one-year forward earnings of GE, it’s trading at 20.4x. In comparison, 3M, Honeywell, and Illinois Tool Works are trading at 20.2x, 17.0x, and 18.9x, respectively.
GE and its peers
GE is more expensive than its peers. It enjoys specific entry barriers, a first-mover advantage, and technologies that are difficult to replicate. These give it a major competitive advantage. But for a large industrial conglomerate such as GE, premiums are justified solely on investor outlook.
Investors interested in trading in industrials can look into the Fidelity MSCI Industrials ETF (FIDU) and the iShares Morning Star Large-Cap Value ETF (JKF).
In the next part, we’ll take a look at analyst recommendations for GE.
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