Wednesday, December 13, 2006

GE: Price-Valuation Divergence is Growing

By Greg Donaldson and Mike Hull,

Donaldson Capital Management

We just completed a look at each stock in the Dow Jones Industrial Average through the lens of our Dividend Valuation Model.

Here's the good news. Among the 30 Dow stocks, the model shows that the average stock is about 10% undervalued. That is an important level because it is the same level of undervaluation that our top-down dividend valuation model is showing.

One of the most undervalued stocks in the Dow is General Electric. The interesting thing about GE is that it has had some good news lately that the market has completely ignored. CEO Jeffrey Immelt recently announced a 12% dividend hike, the third such double digit hike in as many years. He also confirmed earnings guidance for 2007 in the range of 10-13%.

GE has been a disappointing stock for the last few years. But a look at our dividend valuation chart for the company shows a wide gap has formed between the current selling price and the "fair value," as measured by historical relationships between dividends, interest rates and price.

Dividend Valuation Chart

The green candy cane at the far right of the chart below shows our dividend valuation model estimate of GE's price for the coming year. This is not an exact science, but it does give clues about how GE has acted in the past with the dividend growth and interest rates we are predicting for the coming year.

Probably the most important signal we see in the chart is that GE's valuation "steps" have been rising consistently for the last three years while the stock price has been flat to down. While the fit between GE and it dividend valuation is not particularly tight, it is clear that, except for the bubble in the late 1990s, GE's price has trended at the same angle as the model.

The divergence between price and valuation over the past three years is not likely to hold. Either valuation will come tumbling down, and soon, or price has a lot of catching up to do.

Our best guess is that GE might be as much as 25% undervalued.

..............GE Dividend Valuation........

This blog is for information purposes only. Do not buy and sell decisions based on the information contained here. Consult your own financial advisor.