What is Buffett Thinking?

By Ryan Guenette - August 18, 2012 | Tickers: MMM, GE, HON, PHG, SI | 0 Comments

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On June 30 Warren Buffett released his latest portfolio changes for the quarter. Coming as no surprise to anyone, Buffett loaded on 16,710,317 more shares of Wells Fargo and 2,249,696 more shares of IBM. Yet an interesting major subtraction from Buffett’s portfolio was General Electric (NYSE: GE). Buffett liquidated 2,769,275 shares of GE, totaling $57,711,691, based on the closing price of June 29.

Over the past year GE has rallied 30.59%, vastly outperforming the S&P 500, which has only risen 18.5%, during the same period. General Electric continues to appear to be financially strong, so what could have prompted Buffett to sell this industrial giant on its road back to pre-recession levels?

Fundamentals Show Sterling Strength

In 2009, General Electric reported earnings per share of $1.01. In 2014, the average analyst consensus believes GE will derive $1.94 from its business operations. This represents an increase of 92.08% over 5 years, a substantial achievement for a company currently worth $222 billion. Based on these statistics, the company’s compound annual growth rate (CAGR) is 13.95%, a tremendous feat for a company of such size.

During this period, General Electric’s growth is consistent, growing each year during this stretch. Despite this tremendous projected stretch, GE's earnings are currently just a yawn compared to 2008’s earnings per share of $1.64. Additionally, the company currently pays out an annual dividend of $0.68, which at the current price, puts the company’s dividend as yielding 3.23%. Outpacing the 10-year treasury rate and inflation rate, GE’s annual dividend is up from 2011’s annual dividend of $0.60, and is further projected to expand into the future. By 2014, the Street expects GE’s annual dividend to reach $0.88, which at the current price would put the company’s dividend as yielding 4.18%, putting it in an elite group of 4% yielders. From this we can see General Electric’s underlying financial strength, double digit growth rate, and growing dividend.

The chart below display GE's sales, operating profit, net income, net margin, operating margin, earnings per share, dividend, and rate of dividend (the percentage of net income that is paid out in the dividend) over the foreseeable future.

Growth Strategy & the Road Ahead

General Electric is a highly diversified technology company. Their products and services range across numerous fields including aircraft engines, power generation, water processing, household appliances, medical imaging, business and consumer financing, and other industrial products, serving customers in over 100 countries. As an industrial company, it is highly linked to the global economic landscape. When the economic engine is motoring, there is a greater demand for GE's products and services. When the economic environment darkens, General Electric falls drastically. General Electric is a great play on the global economy, and according to the IMF, the trend line is still positive.

General Electric should derive substantial growth from emerging market economies such as Latin America and China. China’s and others’ interest in growing and improving infrastructure should play into GE’s court.

General Electric’s growth strategy will include reinvesting in its core business, acquiring smaller, but faster growing companies, and focusing on the technologies of tomorrow. One of the main things GE will focus on is renewable energy solutions, such as wind turbines and solar panels. The chart below displays the demand for renewable energy over the coming years. The United States government severely supports renewable energy solutions currently, and should and probably will support the development of green energy solutions into the future.

Who is the General of the Industry?

Compared to some of General Electric’s most prominent competitors, such as Siemens AG (NYSE: SI), Koninklijke Philips Electronics NV (NYSE: PHG), 3M Company (NYSE: MMM), and Honeywell International (NYSE: HON), General Electric compares relatively favorably.

In terms of growth, Philips leads the industry, while 3M lags. All companies pay out relatively large dividends, with Siemens possessing the largest and fastest growing dividend in the industry. In the fundamental ratio comparison, Siemens trades with the most attractive multiple, with Philips trading at a premium. When growth is taken into account, General Electric trades at the ideal ratio of 1, while 3M trades at a premium. In the net profit margin comparison, 3M stands out to the upside, while Philips loses money.

The Foolish Bottom Line

When Warren Buffett sells nearly 3 million shares of a company it is worth noting. Many people have made themselves very wealthy by just following the actions of huge investors such as Buffett, yet I believe Buffett has made a mistake in this matter. General Electric has a strong financial profile, double digit annualized growth, and a rock-solid growth strategy. General Electric is slowly recovering from the economic downturn of 2008, and should continue to pay and expand its dividend over the coming years. General Electric is an industrial company, and is highly correlated to the economic environment. Short-term volatility may occur, yet over the long term I believe General Electric is a perfect investment.      

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