An Excellent Play for Diversification and Growth in Your Portfolio
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When it comes to investing for the long-term, diversification is the name of the game. The goal is to spread your investments around enough so your portfolio is not too dependent on any one company or sector, but not to diversify so much that you would be better off buying an index fund and saving yourself the commissions from buying so many stocks. Some companies provide added diversification to your portfolio all by themselves, and my favorite of these is General Electric (NYSE: GE). Let’s take a look at what GE can do for your portfolio, and then we’ll see the variety of investments you would have to make in order to replicate its diversity.
General Electric: past and present
Formed in 1892 by a merger of two electric companies, General Electric was one of the original 12 companies on the Dow Jones Industrial Average when it was formed. Over the following decades, GE broadened its business to include lighting equipment, radios, power generation, computing, and more. Through a series of acquisitions, which have occurred more frequently in recent years, General Electric has evolved into a company with many different, but important business, not all of which have to do with electrical products as the company name implies.
The many faces of GE
Currently, GE operates four divisions (GE Capital, GE Energy, GE Technology Infrastructure, and GE Home & Business Solutions), which can be further divided into eight segments.
Surprisingly, the largest segment of General Electric is GE Capital, which accounts for 31% of the company’s revenue and includes the company’s commercial lending business as well as financial service units for healthcare, media, communications, real estate, aviation, and more. While this segment got the company in some trouble during the financial crisis, causing shares to trade for as low as $5.73, GE has taken steps to restructure its portfolio and improve the credit quality of its assets.
The next largest segment of GE is Power & Water (19% of revenues), which offers various power generation equipment such as turbines, generators, and services for equipment. Aviation (14%) produces and services jet engines, and is a leader in commercial jet engines, as well as engines for military and private applications.
The company’s healthcare segment (12%) produces various medical imaging and diagnostics products, such as magnetic resonance (MR) and computer tomography (CT) equipment. The Oil & Gas segment (10%) produces drilling and production systems, as well as a variety of equipment for drilling applications.
GE’s smaller segments include Energy Management (5%), which is what remains of GE’s original business. Home & Business Solutions (5%) produces GE appliances and lighting fixtures for both consumer and industrial applications. Finally, the Transportation segment (4%) produces and services high-horsepower diesel locomotives and motors for a variety of applications.
In order to replicate the diversity GE brings to a portfolio, you would need (in descending order of relevance) a financial institution, such as Wells Fargo (NYSE: WFC), which is my favorite due to its strong financial position, ambitious growth plans, and its above-average dividend yield of 2.8%. Additionally, even after the 23% gain so far in 2013, Wells Fargo trades for just 11.7 times TTM earnings, and is projected to grow earnings at 8% annually over the next few years.
You would also need a manufacture of engines and power equipment. Pratt & Whitney, which is a subsidiary of United Technologies (NYSE: UTX) is worth a look here, due to its excellent jet engine business, and other revenue streams that come with the company, making it a good diversification play by itself. In addition to jet engines, United Technologies makes Sikorsky helicopters, Otis elevators, and Carrier air conditioners, just to name a few of the company’s products. However, I think United Technology is a bit too expensive right now, trading right at its 52-week high, and at a P/E of 18.5.
We’re not quite done yet! To match the diversification of GE, you would also need a healthcare equipment company such as Hologix, an oil and gas company like Oceaneering, an appliance maker like Whirlpool, and a transportation company like Union Pacific.
So, why buy GE instead?
Not only is GE very diverse, it is also very reasonably valued considering the growth potential of its businesses. GE currently trades at 16.5 times TTM earnings, which are projected to rise nicely over the next couple of years. Most of GE’s core businesses should benefit tremendously from the increase in infrastructure spending and financing, as well as the increased demand for energy that is projected to occur in both the U.S. and GE’s emerging markets. As a result, GE is expecting earnings of $1.66 this year (2013), growing to $1.83 and $1.99 in 2014 and 2015, respectively. This corresponds to a 3-year average annual earnings growth of 9.6%, which more than justifies the P/E.
Additionally, GE pays a very nice 3.2% dividend yield, which it has a great track record of increasing. The current yield represents a payout ratio of less than 50%, meaning that the dividend is in no danger of decreasing, and should increase proportionally to the earnings gains that are expected. The bottom line is that GE is an excellent way to add diversification and growth potential to your portfolio all at the same time.
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Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends Wells Fargo. The Motley Fool owns shares of General Electric Company and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!