One of the stock market’s surprising stars in early 2019 was beaten up industrial conglomerate General Electric (NYSE:GE). GE stock rose from $7 in late 2018, to $10 by early February 2019, as investors took a favorable view on management’s aggressive moves to turn the struggling business around.
Specifically, in early 2019, management divested multiple non-core assets and businesses, simplified the business model, raised cash, reduced leverages, and narrowed the company focus to related businesses with stable long-term growth prospects. The sum of these moves gave investors confidence that GE was in the early stages of turning into a smaller, but better and more valuable company in the long haul. GE stock rallied in response.
But, that rally has been on pause over the past few months. From early February through mid-July, GE stock has been stuck in neutral, bouncing around the $10 range, while the S&P 500 has risen more than 10%.
Why has GE stock gone from out-performer to under-performer over the past few months? More importantly, will this under-performance persist?
Let’s take a deeper look.
Lack of Clarity Has Short-Circuited GE Stock Rally
In the big picture, a lack of clarity regarding GE’s long-term growth prospects short-circuited the big early 2019 rally in GE sock.
In early 2019, General Electric was taking consistent steps towards laying the groundwork for healthier future growth prospects. Most of those steps were centered around non-core asset and business divestitures, which allowed for leverage reduction and more optimal resource allocation. But, such asset and business divestitures have stopped happening over the past few months.
In the absence of these divestitures, investors have started to ask questions. Which businesses will remain after all this shedding is done? How big will GE be at that point in time? What will the growth prospects be like? Will the company successfully reduce its leverage? How long will this whole process take?
None of these questions have clear answers. This divergence between a lot of questions and few answers has created a significant lack of clarity when it comes to GE’s long-term growth prospects. It turns investor optimism into investor caution, which turns a GE stock rally into a sideways trading pattern.
That’s exactly what has happened to GE stock over the past few months.
Lack of Clarity Will Continue to Weigh on General Electric Stock
Unfortunately for bulls, this lack of clarity will persist for the foreseeable future, and it will likely keep GE stock stuck in neutral.
The reality of the GE turnaround is that — because the business is so big and complex with a lot of moving parts — the simplification process will take time. As such, lack of clarity will be inherent to the GE growth narrative for the foreseeable future.
On top of that, global economic growth trends remain sluggish, with the manufacturing sector posting decade-worst growth and heading into a potential recession in 2020. GE has a ton of exposure to the manufacturing sector. Bad fundamentals there is bad news for General Electric stock.
Further, Wall Street has become increasingly cautious on GE stock. According to YCharts, despite the 2019 rally, the sell-side consensus price target for GE stock has actually dropped year-to-date. One could very reasonably argue that the 2019 rally was brought on by undervaluation (GE stock was 30% below the consensus price target in January), and that such undervaluation no longer exists (GE stock is only 10% below the consensus price target today, roughly the same divergence it has had over the past five years).
Broadly, then, current fundamentals imply that GE stock will remain in neutral for the foreseeable future.
Bottom Line on GE Stock
I have faith that GE will downsize around its aviation business, and create a “new GE” within the next five years that is far healthier and more profitable than the GE of today. But, the jump from today to that future requires a leap of faith which investors aren’t willing to take just yet.
They won’t be willing to take that leap until clarity emerges regarding what this company will look like in five years. Until that happens, the best way to play GE stock is by watching it from the sidelines.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
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