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Jelly Roll Capital Equity Research |
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Market Analysis, Education, and Wall Street-Quality Stock Reports |
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Calling Out the Big Dogs: GE, SUNW and ERTS |
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In my April post about my quantitative stock rankings, I singled out big companies such General Electric (GE), Sun Microsystems (SUNW), and Electronic Arts (ERTS) as being in the bottom 5% of all stocks screened. What has happened to them since? The S&P 500 is up 5.98% (using closing prices from Friday), GE is up 3.5%, SUNW is down 13%, and ERTS is down 1% - an average return of –3.5%, trailing the S&P by almost 9.5%. Why did those stocks appear primed for such poor performance at the time, and what is their outlook now after the recent action? I won’t go into an in-depth assessment of General Electric (GE) - I’ll save that for one of the dozens of analysts that follow the company - but it should suffice to say that GE embodies the idea of a “diversified conglomerate.” I see General Electric’s main problem being that they are too big, and it will take some exceptional developments to move the needle on that company’s intrinsic value. Ignore the $375 billion market cap; General Electric also carries a staggering amount of debt with over $300 billion in liabilities. All this means that the company trades for about 23.5x EV/EBITDA, which is quite a rich valuation to be trading for in terms of net income, much less pre-tax and interest. Similarly, although some might argue that GE is “cheap” at “just” an 18x P/E, when debt is factored in that multiple shoots up closer to 40x earnings. I doubt that a company as large as GE will be able to grow earnings at a rate anywhere near the pace necessary to justify such a valuation, and as such I see no reason why most people would want to own this company. Another point of concern is return on capital; GE generates very low numbers here with about a 9.2% EBITDA ROIC, and using free cash flow ROIC clocks in just under 2%. These statistics make me think that GE will continue to be an underperforming investment for some time. Sun Microsystems (SUNW) is a computer systems maker that sells servers, storage, and related services. Although Sun has sales of more than $13.5 billion, their pathetically slim margins translate to a company that has seen a long string of unprofitable years. Although Sun has a solid balance sheet, the almost non-existent earnings of this company and a lack of business catalysts makes me question how low is too low for this stock. Certainly, its current $5-and-change seems much more in-line with reality than $6, and once I re-run the quantitative model I will have a better idea of whether the correction in SUNW went far enough. Computer game maker Electronic Arts (ERTS) is the last dog of the pack, and it has much in common with fellow tech-sector company Sun. Electronic Arts, despite having billions in sales, struggles to turn a profit because of high research and development costs that leave it with nearly no operating income. Yes, ERTS does have a strong balance sheet, but the trend in the video game business toward more complex designs results in massive amounts of R&D spending every year - for what? Most companies do not desire the attainment of marginal profitability, and most shareholders don’t seek out those businesses. In the last decade, annual R&D spending for ERTS has grown nine-fold with no signs of abating. Certainly, bloated R&D budgets won’t be a help to ERTS shareholders, who are already paying more than 35x EBITDA, mainly for the privilege of owning a gaming stock that isn’t Take Two (TTWO), it would seem. |