Monday, June 11, 2018

GE caught many investors by surprise. It shouldn't have

 "The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them." - Peter Lynch, an American investor and mutual fund manager. (1944 -   )


My mother thought she was buying stock in a light bulb company when she invested in General Electric Co. years ago.   Back then GE was the big name in American-made appliances and light bulbs.

Mom loved being modern.

Her GE kitchen wall refrigerator purchased in the early 1950s kept running for 50 years. She loved it and she loved GE.

Mother held on to her GE stock for 30-plus years, acquired more and reinvested the company’s rewarding dividend. By the time she died at age 98, GE held a significant position in her diverse investment portfolio.

She would be surprised to know that GE is no longer a light bulb company. She would be surprised and dismayed to know that GE is in financial trouble thanks to its expansion into commercial lending and long-term care insurance businesses.
When she died, I inherited mom’s GE stock and continue to own it despite the fact the share price has dropped like a stone in the past 12 months and the company has cut its quarterly dividend by half.

This has been a shock to long-time investors who had no idea until lately that GE faces a $15-billion liability from its long-term care insurance business.
Who knew it was in the long-term care insurance business!
Neither did investors have any idea until lately the trouble GE’s finance division faces, left over from the Great Recession of eight years ago.
Why were investors like my mom and now me in the dark?

Because GE was less than honest about what was happening to its bottom line. GE Capital is now being investigated by the U.S. Justice Department because it may have violated federal lending laws in 2006 and 2007.
The company faces a shareholder class action law suit filed by a union pension fund that accuses GE of fraud for misstating the seriousness of its insurance liability.

How are investors supposed to track a company’s financial performance? How are investors supposed to determine if a company is worth investing in and/or whether it might be time sell?
The time to get out of GE stock was back in 2007 but nobody knew that until now.

It turns out GE is not the only company that may be fudging the numbers.

Misleading state of affairs

Jason Zweig, writing in the Wall Street Journal (May 2018), has looked into how U.S. corporations like GE have been and are misleading investors.
In his report, “How companies use the latest profit fad to fool you,” Zweig said that in the past to assess profits, investors have looked to net income, or earnings per share.

But, “over the past two decades or so, companies have come up with newfangled measures of profit. Chief among them: Ebitda, or earnings before interest, taxes, depreciation and amortization.” He said. “This is a modified measure of the cash generated by the business.”

Ebitda is NOT cash flow. It is not net income.

In another recent WSJ article, writer Charley Grant explains how evaluating the financial health of publicly traded health-care stocks is “getting trickier” because a new accounting rule means “companies no longer need to include an estimate of uncollectable debt on their income statements as a deduction from gross revenue.”
Neither do these companies have to mention uncollectible debt as a reduction to accounts receivable on the balance sheet. Huh?

So, what’s going on?

Should investors be worried that they are being lied to? Should we be worried that the rule of law is being eroded, that corporate accountants can muddy the waters, making it hard to make an informed stock investment based on known risk and reasonable reward?

Are financial advisers and brokerage firms going along with the smoke and mirrors? Maybe.
In my mom’s case, she got lazy with her GE stock because it was kicking off a good dividend and going up in share price every year.
By the time she was in her 90s, she did not have the capacity to evaluate the company’s performance at a deeper level. She died happy thinking she still owned a light bulb company.

There still are reliable ways to measure risk and reward when investing in stocks. Here are a few tips (some of them from my mother):
- Buy what you know. Stick with blue chip companies that have a long track record of solid revenue growth.

- Buy companies with a reasonable dividend in the 2 to 3 percent average annual range.

-  Reinvest the dividends for the long-term.
-  At least every six months review your stock holdings: look at revenue growth, stock price performance and the P/E ratio, the comparison of share price to corporate earnings. If the P/E ratio gets over 20, consider selling all or part of your holding in that company. Put the money to work elsewhere. Don’t buy into a higher flyer with a high P/E ratio.
-  Look at corporate earnings growth over several quarters. Steady but moderate increases are a good sign that corporate managers know what they are doing.
-  Stay reasonable. Do NOT make buy or sell decisions based on what happens in Washington D.C.
-  Always balance risk with reward. In stocks, bonds or anything else…the higher the REWARD, the higher the RISK.
-  Count on a free American business news press to keep everyone honest by monitoring corporations and their reports as well as the regulatory arms of federal and state governments.
-  Read the Wall Street Journal, Barron’s, Bloomberg News and other financial news outlets to stay up on the ebb and flow of corporate business news. Pay attention to creeping bad news. Don't be the frog in the pot of soon to be boiling water.
-  Never stop learning, reading and being interested in economic and business trends.

FOR MORE: “How to get started buying stocks.” “Investing Basics FAQs” “5 tips on when to buy your stock.” “Investing help for beginners: 10 things to knowbefore you buy your first stock."

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