Should Dividend Growth Investors Forgive General Electric? Part 1 - The Jack Welch Era
There was a time in the not-too-distant past when General Electric Co. (GE) was the darling of Wall Street and everybody's favorite stock to own. This was especially true during the Jack Welch Era, which spanned the years 1981 to 2000. In truth, I agree that Jack Welch should have been given a great deal of credit for the job he did in profitably running this large conglomerate. However, as I will soon demonstrate, I feel that Jack was given undue credit for General Electric’s stock price action during the last five years of his tenure.
The Jack Welch Era
The following logarithmic F.A.S.T. Graphs™ looks at the record that Jack Welch created at General Electric (GE) over the last decade of his reign. From 1992 to calendar year 2000, General Electric’s earnings-per-share grew at the above-average rate of 13.1% (the orange line plots earnings multiplied by a True Worth™ PE ratio of 15). This orange earnings justified valuation line, represents General Electric’s intrinsic value based on the company’s record of earnings growth over this time frame. The blue line on the graph serves as a barometer and represents a normal PE ratio for General Electric of 25.3.
From the historical earnings and price correlated graph we see that during the years 1992 to 1995, price and earnings correlated very closely as the black monthly closing stock price tracked earnings. However, towards the end of 1995 through year-end 2000, General Electric's stock price rose continuously, ultimately soaring far above its earnings justified valuation. The point I'm trying to make is that I give full credit to Jack Welch for the creation of the orange line, which represents the operating results that General Electric achieved under his leadership. However, the price action results should be credited to the stock market, not Jack, because he has no control over stock price.
My position is that the monthly closing stock price (black line) and the normal price earnings ratio (blue line) were generated by stock market action of which Jack Welch, or any CEO for that matter, has no real control over. Keep in mind that the last years of Jack's reign at General Electric were during the infamous "irrational exuberant period." Therefore, although Jack did a terrific job at General Electric running the company, at the time he was retiring the market was overpricing General Electric’s stock to the extreme.
Consequently, from the nine-year performance results associated with the earnings and price correlated graph below, we discover the shareholder returns that General Electric produced (26% including dividends) were almost double the operating results that Jack produced (13.1% earnings growth and a dividend that increased every year). General Electric closed calendar year 2000 at a price of $47.94, however, the earnings justified valuation (the orange line) only indicated a fair value of $20.
The following F.A.S.T. Graphs™, represented in normal scale with earnings (green shaded area) and dividends (light blue shaded area), even more dramatically illustrate how overvalued General Electric was when Jack retired. Therefore, as I previously stated, Jack deserves a lot of credit for growing the company’s earnings-per-share at such a high rate. However, an irrationally exuberant stock market deserves the credit (or blame) for the high valuation that General Electric was trading at from 1997 to 2000.
Conclusion Part 1
Towards the end of his tenure, Jack Welch aggressively was moving General Electric away from its core manufacturing business towards financial services. Part of this is attributed to the fact that the service industries of which financial services was a major segment had ballooned into three fourths of the US economy by the mid 1990s. Through acquisitions, GE, under Jack’s guidance, expanded financial services to nearly 60% of GE’s revenues. This worked extremely well until the financial services blowout in calendar years 2008 and 2009.
In the late 1990s, Jack also adopted “six sigma,” a quality control program pioneered by Motorola. Jack Welch also established an e-business globalization initiative in 1999. Under Jack’s guidance, General Electric was one of the fastest growing, most profitable and second largest company to only Microsoft (MSFT) by year-end 1999. However, as good as all Jack’s accomplishments were, they did not justify the lofty valuation that the market was placing on General Electric upon his retirement. In Part 2 we will cover the Jeffrey Immelt era at General Electric.
Disclamier: No positions at the time of writing.