The assumptions needed to make GE a good value could be applied to plenty of other companies.

Perhaps the question should be reframed. IF General Electric (NYSE:GE) was the only stock on the market, is it a stock worth buying or not? Lets take a look at the investment case for buying the stock in the context of this consideration.

The case for buying General Electric

In isolation, GE is an attractive stock, and its worth buying for patient investors. This is because GEs highly regarded CEO Larry Culp plans to turn around the under-performing power and renewable energy segments. The aim is to get their profit margins up to high single digits again, so they can start to contribute to cash flow rather than being a drain.

A

Image source: Getty Images.

Meanwhile, the relatively stable healthcare segment will continue to churn out earnings and cash flow, while the aviation segment makes a slow but steady recovery in line with a post COVID-19 recovery in air travel.

If it all goes right, GE could easily be generating industrial free cash flow (FCF) in excess of $6 billion in the next five years. Since the current market cap is only $61.7 billion, the stock would start to look extremely attractive if GE could hit such figures and continue to grow earnings at the rate of inflation or above.

The case for avoiding the stock

The assumptions made above are all well and good, but before buying the stock, there are three downsides to consider: 

First, theres substantial risk around the assumptions needed for GE to hit these figures. Its possible that the gas turbine market (power segment) could decline further as renewable energy is increasingly used to generate electricity. In addition, the onshore renewable energy market remains fiercely competitive, and GEs bet on offshore energy might not bear fruit.

An

GE needs commercial aviation to make a come back. Image source: Getty Images.

Meanwhile, the recovery in air travel is by no means guaranteed at the pace that GE might be hoping for. Not only is GE Aviation exposed, but GE Capitals most important business is GECAS, an aircraft leasing service. Even if you think that the aviation market is now set for a steady recovery from the COVID-19 pandemic, the public and politicians are likely to be highly sensitive to future virus outbreaks all over the world, and pre-emptive actions, like shutting down travel routes, could easily be triggered.

Second, even if you are happy with the assumptions of a recovery in commercial air travel and the global economy, you still have to make the case that GE is a better value compared to its peers like Raytheon Technologies and Honeywell.

Price to Free Cash Flow

2020Est

2021Est

2022Est

General Electric (NYSE:GE)

N/A

27.6 times

18.6 times

Honeywell International (NASDAQ:HON)

22.4 times

19.7 times

17.5 times

Raytheon Technologies (NYSE:RTX)

34.9 times

15.9 times

13.2 times

Data source: Marketscreener.com, authors analysis. Free cash flow 

In addition, Raytheon actually has 55% of its revenue coming from defense, and Honeywell is a far more diversified industrial company overall.  In short, the other two aviation-heavy industrial conglomerates have relatively less exposure to commercial aviation and are trading on better valuations. 

To be fair, GE has the potential to increase its FCF by more than the others in the next few years after 2022. But longer term, the other two are arguably positioned in more attractive end markets than GE.

Third, another way to assess GE is to compare this company with a basket of companies that have end market exposures similar to each one of GEs segments.

In this way, investors can compare GE with a collection of companies, such as Danaher in healthcare, TPI Composites wind power and Heico and/or TransDigm in aerospace. You could buy a basket of such stocks and avoid some of the areas of risk inherent in holding GE.

Is General Electric a buy?

In isolation, GE stock is attractive on a risk/reward basis but only for long-term investors. However, in the real world, there are plenty of other investment options out there, and its hard to argue that GE is a better value than its peers. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Lee Samaha owns shares of Honeywell International. The Motley Fool owns shares of and recommends TransDigm Group. The Motley Fool recommends Heico and TPI Composites. The Motley Fool has a disclosure policy.

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