Making money in the stock market is easy. All you need to do is follow a few simple rules when it comes to choosing stocks to buy. The most important of these rules is to locate companies that are undergoing transformational yet shareholder value enhancing changes. The bigger and more exciting these transformations are, the better for the share price. Wall Street loves nothing more than a big exciting story attached to a major company name. The excitement attracts profit hungry investors who are looking to ride the changes to profits.
Share buy backs, dividend enhancements, institutional interest and spin offs all offer a very strong potential to dramatically increase shareholder value. When these items are combined with a major component of the Dow Jones Industrial Average, the potential gains can be very large for investors who jump onboard early. Add in the fact that these bullish catalysts are presently taking place in a company with an over $270 billion market capitalization that is owned by nearly every large institutional buy side firm and it spells tremendous opportunity.
Prior to getting into the specifics of the company, it’s important that you understand why these catalysts have such a bullish affect on share prices.
First, share buybacks are when a company uses its extra cash to purchase its own shares. This has the effect of reducing the number of shares on the open market. The reduction in the number of shares means that each share is worth more since the actual real value has not changed. A good way to think about this is simple supply and demand. When supply is reduced and demand remains the same, prices are forced higher. This is how share buybacks enhance shareholder value.
Secondly, companies that are increasing their dividends are very attractive to a multitude of different investors. Income investors, pension funds, insurance companies and other long term holders of equities earn a substantial sum from dividends. As these dividends are increased, long term holders often increase their holdings by purchasing additional shares to capture even more income from dividends. In addition, companies that are increasing dividends are often signaling that things are expected to stay bullish within the company. Every type of investor takes this as a strong buy signal.
Thirdly, spin offs are very bullish for both the company spun off and the parent company doing the spinoff. The company spun off benefits from being decoupled from the often staid corporate culture of the parent, often new management, and an entrepreneurial spirit that is normally only reserved for IPO’s and other start-ups. The parent company can benefit in many ways by spinning off divisions. These ways can include a cash infusion from the sale, saving money by divesting of an unprofitable business, as well as the positive bullish attention that these types of activities bring to the company.
Finally, institutional interest is an extremely bullish factor. This is particularly true in companies that are considered under owned by institutions. The company I am referencing is in this category. Despite being already owned by a substantial number of hedge funds, ETF’s, index following and blue chip mutual funds it is still considered to be under-owned by many analysts.
Tom Donino, co-head of equity trading at First New York Securities, explained it this way “The stock has been under-owned by institutional investors, and that’s going to change now.” What an incredibly bullish statement!
If you haven’t guessed it already, I am talking about the 10th largest company in the United States, when measured by market capitalization, General Electric (NYSE:GE).
This well known company is a diversified infrastructure and financial services company. The products and services of the Company range from aircraft engines, power generation, oil and gas production equipment, and household appliances to medical imaging, business and consumer financing and industrial products.
However, this stalwart of the Dow Jones Industrial Average is undergoing a huge transformation with every bullish catalyst, mentioned above, in full effect.
In fact, shares jumped over 8% when this news first hit the wire. Things have settled down since the first burst of news, but these bullish catalysts will very likely continue to push this once boring company higher over the long term.
CEO Jeffrey Immelt sees the restructuring as a return to the company’s core competencies. He explained to Bloomberg, “We’re always looking for ways to grow our industrial businesses. We’ve got so many investment opportunities in the businesses we’re in today — oil and gas and healthcare and aviation.”
Here’s a closer look at exactly why this transformation is expected to be very bullish.
First, General Electric is close to a deal to spin off its real estate portfolio to the Blackstone Group and Wells Fargo for $30 billion. GE sees this as the ideal time to sell as commercial real estate prices have finally surpassed the 2007 boom. The price surge in commercial properties is due to foreign and domestic investors capitalizing on close to zero interest rates. The sale is expected to create as much as $4.75 billion in profits for General Electric.
Secondly, GE is dumping its finance unit and has a plan to return as much as $90 billion to investors. The company announced that it is undergoing a major transformation including a $50 billion share buyback program and divesting of most of GE Capital. GE Capital is a giant with $275 billion in assets including Synchrony Financial credit card unit and consumer lending and banking.
Next, buying back the shares reduces the float. In turn, this reduction of the float, works to increase the dividend growth rate.
At the same time, GE plans to retain approximately $90 billion in finance assets that are directly tied to selling products like jet engines, power generation, medical equipment and electrical grid assets.
The share buyback program, which will be partly funded by $35 billion through money returned from GE Capital. It is the second-biggest in history after Apple $90 billion plan. GE, which had 10.06 billion shares outstanding on Jan. 31, said it expected to reduce that by as much as 20 percent to 8 billion to 8.5 billion by 2018.
Perhaps, most bullish, is the fact that GE is forecasting profits to be substantially higher by 2018.
Now it is important for investors to note that the dramatic reduction of GE Capital is expected to reduce the company’s earnings by $0.25 per share. However, the buybacks should more than compensate for the earnings reduction.
As GE’s CEO aptly stated above, the company’s goal is to become nearly 100% industrially focused. The reason for this is that by spinning off the finance units, GE will be able to avoid costly, post crisis regulatory scrutiny.
Not only will the company be able to ramp up share buy backs with its huge hoard of cash, it will be able to acquire industrial assets to help grow its core competencies.
Technically, price has started to pull back from the gap higher level of $28.50 per share. This provides investors an opportunity to purchase shares at a discount from the highs. Going long in the buy zone between $27.00 and $28.00 per share makes sense. Initial stop loss is suggested at $25.73 per share and the target price is $37.00 per share.
While it may take some time for the share price to gain traction after the initial gap higher, patience should pay off handsomely for long term investors in GE.