Is The Price Right For Conglomerates?

By Will Ashworth | August 25, 2009 AAA

In his book The Guru Investor, John P. Reese details the investment principles of eight of the world's greatest investors; showing readers exactly how to use those principles to outperform the market. Reese knew there was a way to beat the markets and so was born a quantitative, yet effective system for building portfolios.

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Ben Graham's Rule Of Thumb
One of Benjamin Graham's rules was to avoid any company whose price-to-earnings (P/E) and price-to-book (P/B) ratios, when multiplied together, totaled no more than 22. My rule adds price-to-sales (P/S) and price-to-earnings divided by price/earnings to growth (PEG) to Graham's two ratios.

Only those companies with a total below 100 qualify for further study. Using the conglomerates industry and its five largest capitalized companies as my sample, two make the cut: General Electric and United Technologies.


Top 5 Conglomerates By Market Cap

Company P/E TTM P/B P/S PEG Total
General Electric (NYSE:GE) 11.23 1.35 0.88 1.74 23.21
United Technologies (NYSE:UTX) 13.59 3.21 1.03 1.99 89.42
Danaher (NYSE:DHR) 17.26 1.88 1.70 1.87 103.15
3M (NYSE:MMM) 17.98 4.69 2.22 1.80 336.97
PPG Industries (NYSE:PPG) 40.27 2.81 0.67 7.13 540.57

General Electric is the only stock of the five above that qualifies under Graham's rule of 22. Under my rule, we have an additional company to analyze. GE's four ratios are all lower than United Technologies. By Graham's standard, its margin of safety is clearly superior to United Technologies, the Hartford-based maker of helicopters (Sikorsky), aircraft engines (Pratt & Whitney) and air conditioning systems (Carrier). But is GE the better company?

P&L Statements
General Electric made $94.3 billion in net profits over the last five years from $766.6 billion in revenues for an overall net margin of 12.3%. United Technologies generated $18.4 billion in net profits from $241.4 billion in revenues and an overall net margin of 7.6%. The winner of round one is General Electric.

For GE, its second quarter report was mostly bad news mixed in with a few snippets of good news. Revenues were off by 17% to $39.1 billion, $3 billion less than analyst estimates and net earnings dropped 49% year over year to $2.6 billion. Its GE Capital unit was hit hard, delivering a profit of $590 million, 80% lower than a year earlier. Apparently it still has some serious loan losses to deal with.

On the bright side, EPS beat estimates by a penny and global stimulus business could bring the company as much as $190 billion in future revenue. While business could be a lot stronger, a yard sale where everything must go isn't imminent.

As for United Technologies, it too saw a drop in second-quarter revenues, missing analyst estimates by $720 million. On a positive note, it beat EPS estimates by a penny, $1.05 to $1.04 from analysts. It was a tough quarter for UTX with only its Sikorsky division growing revenues. In its Q2 conference call, management cut full-year guidance for EPS to $4.00-$4.20 with revenues around $53 billion, $2 million lower than its previous forecast. Like GE, the news is currently negative overall.

The Bottom Line
These are both excellent companies stumbling a bit in this economy and that's perfectly understandable. There's not much to tell them apart but I'd buy GE over UTX for two reasons: first, you'd be getting the conglomerate at a fantastic price and second, Warren Buffett, the most famous of gurus, already owns 7.7 million shares as well as warrants to buy another 134.83 million at $22.25 a share. Need I say more? (For more, see Conglomerates: Risky Proposition?)

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