How to Think of GE
General Electric (NYSE: GE) is a company that’s struggling. That’s been true for some time for the company that was once the envy of the stock market and the subject of many business school case studies. Now, the company continues to be the focus of business schools as analysts question its future.
Traders have been negative on the stock for much of the past year.
Why April 27th Could Set Off A “Tech Boom” In Stocks
Thanks to the rare convergence of three economic triggers, the clock is ticking down for a once in a lifetime wealth building opportunity.
Of course in the late 1990s, GE was in a different position as the long term chart below shows.
The stock is now trading at levels briefly touched during the financial crisis and last seen in 1997. The question for investors is whether the company can rebound.
Analysts Have Mixed Opinions
Barron’s recently summarized the view of three analysts who cover the company.
Melius Research’s Scott Davis reiterated a Buy rating and $27 price target–which is more than double where the stock is trading this morning. He writes that there is “some light at the end of the tunnel, but admittedly requires a lot of patience.”
Fundamentally, GE is lagging behind peers that continue to deliver ‘beat-and-raise’ quarters, and Davis admits that there isn’t a quick fix for the stock.
That said, he argues that the shares, down 49% in the past year, are already discounting GE’s many woes, but not any positive surprises “of any substance” on costs or asset sales.
He believes that companies in “motion,” that are shaking up their portfolios, tend to “outperform nicely but are never easy.”
Davis also points to “massive value creation” at other restructured companies, like Honeywell International (HON), Illinois Tool Works (ITW), etc., bolstering his case that the “success rate of break-ups and spin-offs is amazingly high in industrials,” even for those businesses that investors think are permanently impaired.
Oppenheimer’s Christopher Glynn is less enthusiastic. He reiterated a Perform rating on the shares, writing that GE’s selloff was largely due to the narrowed free-cash-flow outlook on ongoing weakness in its power business.
He estimates GE’s $6 billion 2018 free cash flow reflects about $2.3 billion for the remaining company after it sheds its healthcare unit, Baker Hughes (BHGE) dividends and other assets, and a pro forma market cap of $55 billion, compared with the current $115 billion market cap.
“Relative to $2.3B, not a compelling value siren,” he concludes.
Finally, Barron’s cited Argus’s John Eade downgraded GE to Hold from Buy today, citing Friday’s report.
He doesn’t mince words, writing that he was bullish on the shares previously because he thought he saw signs of a turnaround in the company’s first-quarter earnings.
“However, the second-quarter results were a step in the opposite direction,” putting GE behind the eight-ball in terms of meeting its low-end full-year targets.
The “steady flow of bad news from the company,” and its dividend cut was too much for Eade, a self-described long-term supporter of the stock.
He is sure that the company will look totally different in a few years, and management is taking “bold” steps, but ultimately, Eade warns that “the near-term outlook for two of the remaining core businesses – Power and Renewable Energy – is bleak.”
No matter which analyst is right, the company could be a solid choice for income investors expecting a long term up trend in the stock.
Trading the Trend
When a stock is expected to move higher, traders could consider obtaining long exposure to the stock to profit. A number of options strategies could be used to meet this objective.
Among those strategies is a bull put spread. The risk and reward diagram is shown below and it offers limited risk with limited potential gains. However, it is well suited for a stock which is in an up trend.
Source: The Options Industry Council
This strategy involves two put options. One put option is bought and a second put option with the same expiration date but with a lower exercise price is sold. Selling the put option will generate immediate income, just like the more familiar covered call strategy would. But, unlike a covered call, risk is limited.
Many traders will be familiar with the idea of a covered call. This is a conservative strategy many long term investors use to generate income in stocks they own that are unlikely to make large moves.
Although the bull put spread is different than a covered call, the bull put spread strategy meets the same objective as the covered call which is to generate some income. This trade generates immediate income and carries limited risk.
A Specific Trade for GE
For GE, a bull put spread could be opened with the August 10 put options. This trade can be opened by selling the August 10 $13 put option for about $0.35 and buying the August 10 $12 put for about $0.10.
This trade would result in a credit of $0.25, or $25 per contract since each contract covers 100 shares. That amount is also the maximum potential gain of the trade.
The maximum possible risk is the difference between the exercise prices of the two options less the premium received. For this trade, the difference between exercise prices is $1 ($13 – $12). This is multiplied by 100 since each contract covers 100 shares.
Subtracting the premium from that difference means, in dollar terms, the total risk on the trade is then $75 ($100 – $25).
The potential gain is about 33% of the amount of capital risked. This trade will be for about three weeks and the annualized rate of return provides a significant gain.
The bull put spread is an example of how options are a versatile tool that could meet many of your trading objectives. In this trade, options provide income and defined risk that could be lower than owning the stock. This strategy also has a high probability of success.
These are the type of strategies that are explained and used in TradingTips.com’s Options Insider service. To learn more about how options can be used to meet your goals, click here for details on Options Insider.