General Electric Co. (NYSE: GE) trades at a 4% conglomerate discount. A conglomerate owns many different businesses -- which do not share resources. The rationale for conglomerates was that they allow investors to buy a diversified earnings stream -- when one business is up the other is down and vice versa. In theory this makes earnings smoother.
Finance theory suggests that conglomerates should trade at a discount to the stand alone value of those businesses. The reason for the conglomerate discount is that investors are able to construct a portfolio of stocks that will achieve the diversification themselves. Thus all the overhead needed to manage these diverse businesses under one umbrella adds cost without creating offsetting investment value.
One way to test this theory is to compare the weighted average price/earnings (P/E) ratios of the industries in which GE competes with GE's overall P/E. When I did this, I found that if each of GE's business units was a stand alone public company, its industry P/E weighted by its proportion of operating earnings to the total, averaged out to 19.9. This is substantially above GE's P/E of 19.1, suggesting that GE trades at a 4% conglomerate discount.
I got to the 19.9 P/E by multiplying each business unit's industry average P/E by its share of GE's corporate operating income. Here are the components of the calculation:
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Infrastructure P/E: 19.6 x 37% of total operating income = 7.24
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Commercial Finance P/E: 15.8 x 21% of total operating income = 3.28
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GE Money P/E: 15.8 x 14% of total operating income = 2.19
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Healthcare P/E: 24.8 x 10% of total operating income = 2.48
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NBC Universal P/E: 30.7 x 12% of total operating income = 3.78
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Industrial P/E: 15.5 x 6% of total operating income = 0.95
Due to the imprecise nature of these estimates, it is hard to rely on the exact amount of the conglomerate discount I calculated earlier. For example, I am troubled that the Broadcast TV industry average P/E of 30.7 is much higher than that of the comparable companies I used in this analysis of NBC Universal's value.
Nevertheless, I think this is a useful way to think about how each business detracts from or contributes to a conglomerate's stock market value. And it makes me think that it may be worthwhile for GE to analyze further whether a conglomerate is the right corporate strategy.
Any comments on this series would be welcome.
Peter Cohan is president of Peter S. Cohan & Associates, a management consulting and venture capital firm. He also teaches management at Babson College and edits The Cohan Letter. He owns GE shares.
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Reader Comments (Page 1 of 1)
7-30-2007 @ 1:28PM
steve holben said...
Again, like I said on an earlier one of these. It seems whenever "experts" start opining on anything it's time to run for the hills. There's FAR FAR FAR to many "experts" for just about everything under the sun, and the vast majority of them should keep their opinions to themselves. I've watched my industry (housing) get thoroughly vilified by a lot pf people who have no idea what they're talking about.
Steve Holben, Holben Biulding Corp. for over 30 years!
7-31-2007 @ 1:05PM
j.c. said...
mr. holben is correct. the pundits make a living dispensing their "knowledge" except they never have to pay the price when they are wrong. if they ever had to bring a business in against financial and market metrics god knows how pitiful they would perform. when GE was $60 why weren't these people criticizing it for being a conglomerate. their P/E and P/R analyses and theories of "like synergies" remind me of the lochness monster....often talked about but rarely seen.
8-01-2007 @ 3:26PM
Nane Aluli said...
I like GE and view your evaluation as very positive. I'm not a financial wizard or MBA analyst, but I think that a company that has good fundamentals, solid management, positive corporate culture and strong financials makes for a good company that returns value to the investor. I think GE provides that now and will continue to do so. Going forward I think GE is a really positive investment.