Thursday, May 12, 2016

Stocks and the GE Example ... Buy, Sell or Hold? ... Comparing Stocks to Bonds for the Long Haul .... Which Is Better?

Occasionally I'm asked to give my views concerning the investing wisdom and risk associated with buying bonds vs. investing in stocks.

For the past decade or longer, I've always answered that stocks beat bonds by a whole bunch and cash or cash equivalents by even more.

Let's use GE stock as an example. One financial firm recently recommended that GE be sold or at least not be bought. Perhaps the price of GE's shares will fall or at least won't rise for the foreseeable future. But then again, perhaps it will. I don't know which, and nobody else does either.

In any event, GE is a solid and diversified company with plenty of cash, a strong management and a healthy dividend which it increases almost every year.

Currently its cash dividend yield is ~3% compared to a 10 year government bond, which yields only ~1.75%.

If GE's income grows by 7% annually on average the next decade, its stock price should roughly double. That's the simple and magical rule of 72 and compounding at work.

But that's not all there is to the story. The cash dividend should double in that time as well. Assuming it does so, that would equate to an approximate 6% dividend yield based on the price of its shares today.

Thus, a $100 investment paying a $3 cash dividend today would grow to a $200 investment with a cash dividend of $6 in ten years.

That would be in contrast to getting $1.75 annually on the government bond and having our initial investment of $100 returned to us in ten years.

A 'safe but called risky' investment worth $200 in value with accompanying annual cash payments of $6 makes more sense to me than $100 and $1.75 in annual cash payments, which I would argue is a 'risky but called safe' investment.

And that's why I own stocks of stable blue chip dividend paying and dividend growing companies instead of investing in 'safe' government or other bonds or cash equivalents.

GE Offers Dependable Growth and Income Too is subtitled 'JP Morgan sees 10% downside. But with healthy fundamentals and a 3% dividend yield, GE looks like a buy.' {NOTE: Today's Barron's article is copied below in its entirety since it may not be accessible to non-subscribers otherwise.}

"JPMorgan doesn’t expect General Electric to keep powering higher.

Early Thursday, analyst Stephen Tusa became the latest voice on Wall Street to raise concerns about the conglomerate, resuming coverage on GE with an Underweight rating.

Tusa says that the company’s “bold portfolio transformation” and solid technology potential are more than reflected in a stock price that has climbed 15% over the past 12 months, easily outperforming the Standard & Poor’s 500.

Tusa sees GE’s share price falling about 10% over the next year to $27. He worries that high expectations will result in low returns and that the company’s 2018 per-share profit target of $2 “will remain elusive” due to mixed fundamentals. The stock closed down 0.8% Thursday to $30.09.

Is it time to give up on GE? We don’t think so.

Granted, the company’s latest earnings report, announced on April 22, did little to bolster confidence amid continued pain in the oil patch and a sluggish economy. Revenue fell short of some published estimates, and the company cut its forecasts for its beleaguered oil and gas business after revenue there fell 18%.

Yet as Barron’s noted last month, profit is rising at a double-digit pace. And, activist Nelson Peltz’s Trian Fund Management invested $2.5 billion in GE in October, predicting a 70% upside for GE stock.

GE offers a market-beating 3.1% dividend yield. The company is buying back stock and using the more than $100 billion in cash on its balance sheet to aggressively pursue deals.

Earnings per share are expected to increase 15% from $1.31 last year to $1.51 this year and then rise 16.5% to $1.76 in 2017.

GE trades at 19.9 times expected 2016 earnings per share and 17 times expected 2017 earnings.

In GE’s largest deal yet, it paid $10.3 billion for the grid businesses of French turbine maker Alstom ( ALSMY ). GE also spent $250 million in cash earlier this week for the power plant unit of Doosan Engineering & Construction. And now, the company is seeking deals to complement its growing software business and searching for opportunities in the oil and gas industry.

GE launched an initiative to transform into a pure-play industrial company last year. As of the end of March, the company had signed sales for $166 billion in real estate and financial assets, and last week raised $749 million selling shares in an initial public offering of its Czech banking unit.

Granted, GE’s oil and gas unit won’t quickly rebound. But Citigroup analysts Andrew Kaplowitz and Vladimir Bystricky argued last week that the unit is well positioned long term and could stabilize this year if current market conditions hold steady.

Oil prices have rallied since sliding below $27 a barrel in January, with futures for the U.S. benchmark WTI crude inching slightly higher today to a recent $46.44 a barrel.

While it could be next year before GE hikes its dividend, its yield far exceeds the 1.75% paid by the 10-year U.S. Treasury note, which should comfort long-term investors."

Summing Up

I currently have an 'overweighting' of GE stock in my personal investing portfolio. It's worked out very well for me over many years.

In fact, I tend to view it, along with other blue chip dividend payers, as a proper substitution for an investment in bonds. The stock's dividend yield is higher than bonds currently and, unlike the case with bonds held to maturity, its share price tends to increase as earnings increase over time as well.

Compared to bonds, GE's stock has been and continues to be an investing 3-fer for me due to (1) cash dividends exceeding interest on bonds, (2) increased cash dividends over time and (3) a higher share price over time as well.

While there are no guarantees, there are smart moves and not-so-smart moves.

I view owning GE for the long haul as a smart move.

Other examples are Boeing, Pfizer, Johnson & Johnson, Cisco, Microsoft, JP Morgan, and Wells Fargo. There are several other blue chip dividend payers worth considering as well.

For the more venturesome among us, Exxon, Wal-Mart, McDonald's, Ford and General Motors may be worth a look as well.

That's my plan and that's also my take.

Thanks. Bob.

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