General Electric Company (NYSE: GE) is a global diversified infrastructure and financial services company known for its top-notch aircraft engines, power generation and energy equipment. General Electric is a conglomerate, which makes it somewhat difficult to compare to other companies. It is worth reviewing several of General Electric's relative valuation and profitability metrics, such as the price-to-book (P/B) ratio, dividend yield, operating margin and return on invested capital.
The P/B ratio reflects the market expectation of a company's earnings power and cash flows in relation to its book value of equity, which is an accounting metric updated four times a year and based on a company's historic performance. The P/B ratio can be greatly affected by a company's acquisition accounting, share buybacks and outstanding options, resulting in vastly divergent P/B ratios among firms even within the same industry. Certain analysts take very good care of adjusting equity book values for companies before making comparisons.
General Electric's P/B ratio was 2.6 in February 2016, which is slightly lower than the 2.8 average for the diversified industrials industry. In comparison, the average P/B ratio of companies in the S&P500 Index stood at 2.5. From 2006 to 2015, General Electric's P/B ratio ranged between 1.4 to 3.4, and the average P/B ratio was 2.14. A company's P/B ratio can vary due to three main metrics, which are returns on equity (ROE), expected earnings per share growth and risk. An investor must assemble a relevant sample of companies and compare these metrics to make a value call. Otherwise, General Electric may seem vastly undervalued in comparison with 3M Company, which has a 7.8 P/B ratio. However, 3M Company has a 35.08% ROE compared to General Electric's -5.91%. ROE alone can explain most of the variation in companies' P/B ratios.
Dividend yield is another price metric that is especially relevant for investors interested in current income stock investing. While dividend yield should never be the sole basis for making stock purchases, stocks that have higher dividend yields but the same valuations as their peers may receive more favorable treatment from income-seeking investors. Dividend yield that is very high by a company's historic standards may point to a market expectation of an upcoming dividend cut.
General Electric demonstrated a 3.2% average dividend yield in February 2016, which is much higher than the diversified industrials industry's 2.4% average. By historic standards, the company's dividend yield is in line with its 3.2% five-year average yield from 2010 to 2015. Over this period, General Electric experienced declines in consistently lower operating cash flows in a challenging environment for industrial goods. However, the sale of GE Capital proved a liquidity boost for the company and put its industrial line of business at the center. Income-seeking investors should carefully assess General Electric cash flows going forward for any warning signs of decline.
A company's operating margin tells how effectively it runs its business to generate operating profits in proportion to its sales. From 2005 to 2014, General Electric saw its operating margin steadily deteriorating from a 27.43% peak in 2006 to 17.99% in 2014. The company had a 17.98% operating margin for the trailing 12-month period ending on Sept. 30, 2015. Its current operating margin still favorably compares to many of its peers, such as Siemens AG, ABB Ltd., Honeywell International and Danaher Corporation.
General Electric has very strong competitive advantages in its industrial equipment portfolio. However, the company's operating margin can experience further pressure in the short term as economies around the world are coping with lower commodity prices and slowdown in global growth.
Return on Invested Capital
ROIC is another useful metric that reveals how much after-tax operating profits a company earns relative to its total capital, which includes net debt and equity. Companies with high ROICs above their cost of capital can indicate wide economic moat and the ability to deliver value to shareholders. From 2005 to 2014, General Electric demonstrated an average ROIC of 5.54%, and its ROIC turned negative to -0.28% for the trailing 12-month period ending on Sept. 30, 2015.
The dip in the company's ROIC is primarily attributed to loss from discontinued operations coming from the sale of GE Capital. Yet, with divestiture of most of its financial operations, General Electric is poised to recover its ROIC into positive territory. However, investors should keep in mind the company significantly lagged behind its closest peers in ROIC, and it will take a lot of effort to raise this aspect going forward.