GE surprised Mr. Market late last week. Now... Mr. Market has the wisdom of a four-year old hopped up on cotton candy, so surprising him is about as difficult as replacing a light bulb. We offer you a more substantial (and sober) review of GE's earnings, below.
Here's a preview: We are less than impressed. In fact, we view the whole charade as sad and tawdry. It's flimflam on a grand scale, from no less than what used to be America's greatest corporation...
Let's begin with the much-ballyhooed dividend increase. GE says it will now pay out $0.12 per share every quarter instead of $0.10. While it is true that $0.12 is 20% more than $0.10, we doubt this arithmetic is very meaningful to bona-fide shareholders, who were collecting a quarterly $0.31 per share until early 2009.
The last time GE shareholders saw regular dividends around $0.12 per quarter was last century – 1999 to be specific. So, while you may regard this dividend increase as a significant step in the right direction, you might also see this extremely low payout level as the result of a "lost decade" at GE.
No matter how you view the news – as an exciting surprise or as a disheartening reality – there is one objective way to measure the dividend: by the yield it will produce for shareholders. Assuming GE continues to pay investors $0.12 per quarter, and assuming you buy the stock today for $16 (where it's trading now), you will earn a grand total of 3% per year on your capital.
GE's managers also want you to know its earnings were up last quarter – by 15%, to $3.3 billion. The results are so good, the company has promised to "extend" its share buyback program.
We've never seen that term used this way before. GE's managers clearly believe it's good news for shareholders. But what it really means is the company never bought the stock it promised to buy back previously. So the deadline for purchasing the stock had to be "extended." Imagine if your employer told you, "Great news, Bob, the company made more money than we thought it would, so we're going to extend your bonus payment – the one we didn't send you last year – to 2015."
Oh... one more thing. It's true that GE's reported earnings increased. But what the managers didn't mention was the company accomplished the increase despite a 4.3% decline in revenues. As any pizza chef can tell you, skimping on ingredients will only carry you for so long. Sooner or later, you gotta actually make more dough.
Finally... here's what GE CEO Jeffrey Immelt definitely didn't mention along with the promised 3% dividend and the "extended" buyback program: negative amortization mortgages.
When you think of GE, you probably think of its slogan: We Bring Good Things to Life. What GE actually does, however, is run a huge, highly leveraged global hedge fund that's almost totally unregulated. And the upcoming losses from this enormous financial operation will almost surely overwhelm the company's ability to finance its matching debtload. Let's run down the real numbers...
GE Capital has nearly $600 billion in assets. That's roughly 75% of all of GE's assets. When we say GE is really a giant, unregulated, global hedge fund, that's what we mean: Three-quarters of its assets are committed to the hedge fund, which it calls "GE Capital."
GE Capital does what most banks do... It borrows a ton of other people's money, invests it in ridiculously risky projects, and pays out bonuses to its managers, who retire before anyone realizes how much money they've lost.
GE Capital's nearly $600 billion in assets include $333 billion in receivables (think credit cards, car loans, and mortgages), $53 billion in property (think commercial real estate), and $81 billion in "other." We have no idea what "other" represents and would challenge anyone outside the company to explain it to us, as GE Capital's reporting is entirely indecipherable. Here's a good example... In one of its dozens of summary pages regarding its real estate investments, you will find this footnote: "Includes real estate investments related to Real Estate only."
We've never found a company that couldn't make its business easy to understand if it chose to do so. Warren Buffett, for example, runs a business that's similar in scale to GE. He writes the annual report personally, going over every key business unit in plain, clear English. GE's reporting is complex because it doesn't want you to know what's happened.
In any case... even assuming all $81 billion of "other" is money-good, we still believe the company is likely to declare bankruptcy because of investment losses within the next three years. Here's why: The company's total tangible net equity is only $40 billion. Thus, if GE were to lose 7% across all of its investments, its equity would be completely wiped out. In truth, whole book losses of even 2% or 3% would spook the capital markets enough that GE wouldn't be able to roll over its debts. And its near-term capital needs are massive: $227 billion comes due before the end of 2013.
We think its investment losses will total more than $50 billion over the next two to three years. Here's why...
GE Capital's total European exposure is $95 billion – that includes credit-card debt, auto loans, and mortgages. Any significant decline in the value of the euro would cause massive losses in these investments. And even if nothing bad happens to the euro currency (and we believe the euro must soon either be significantly devalued or significantly restructured), GE is still likely to lose an enormous amount of money on these loans. The reason why is buried in a footnote on page 21 of its second-quarter credit-quality report. It says:
"...At origination, we underwrite loans with an adjustable rate to the reset value. 81% of these loans are in our U.K. and France portfolios, which comprise mainly loans with interest-only payments and introductory below market rates..."
What that means is that GE Capital invested heavily in interest-only, variable-rate mortgages in the U.K. and France. Most of these loans haven't "reset" yet. And when they do, they have enormously high default rates.
Specifically, in the UK, 24.9% of GE's mortgages are more than 30 days delinquent. In Spain, almost 30% of GE's mortgages are 30 days or more delinquent. On average, of $50 billion in non-U.S. mortgages, more than 14% are delinquent. We estimate that at least 50% of these loans will end up defaulting.
According to Wells Fargo, defaults on these types of loans have been producing losses of between 60% and 70%. So... if you assume half of the mortgages default and you assume loss severity of 70%, GE should see losses on its non-U.S. mortgage portfolio of between $15 and $20 billion – not including losses on its $160 billion American mortgage portfolio... not including its commercial real estate losses... and not including its exposure to a euro currency crisis.
For taking on all of these risks, Immelt is offering you 3% a year. Plus a share buyback that's been "extended." Any takers?
Kudos to Jeff Clark... New home sales jumped 24% in June, and Short Report readers picked up a quick, 100%+ gain today after closing half their position in Jeff's housing trade. On July 3, Jeff recommended buying calls on homebuilder KB Home, noting the industry had been "viciously oversold."
While the recent volatility has been killing most investors' portfolios, Jeff thrives on it. He made his fortune taking advantage of extreme sentiment in the markets... And thanks to today's shaky market, Jeff is seeing fantastic opportunities almost every week. His technical indicators – which he's honed during his decades in the securities industry, managing money for some of Silicon Valley's wealthiest – have alerted him to several huge opportunities this year.
Two weeks ago, Short Report readers pocketed 56% in three days going long the S&P. Jeff also recommended going long oil in May. That trade returned over 140% in less than a month. He's also made 126% in six days trading gold, 106% in two weeks trading the transportation index, and 93% buying Mexico.
If you've never tried trading options with Jeff Clark, today's market is the perfect opportunity. And his latest trade should be another big winner. One of Jeff's favorite market indicators is screaming "sell." After its recent rally, Jeff believes the S&P 500 will break down. Specifically, Jeff said he's never seen the market move against this indicator in the 20 years he's followed it.
To learn more about the S&A Short Report, and access Jeff's favorite short play right now, click here.
New highs: Altria (MO), EV Energy Partners (EVEP), AmeriGas Partners (APU), Kinder Morgan Energy Partners (KMP), Enterprise Products (EPD), Western Digital (WDC), Anheuser-Busch InBev (BUD), Keyera Facilities Income Trust (KEY-UN.TO).
It sounds like people are heeding our calls to sell stocks short and try trading options. We'd love to hear more about your experiences with these strategies... feedback@stansberryresearch.com.
"The people that wrote about Federal jobs are 100% correct. I should know. I am a COTR and I know most people have no clue what that is. The people that wrote about Government job will know who the COTR is. They have to deal directly with them. In short I write Government contracts and run the jobs. One of the biggest things I have to keep track of is that the employees are getting paid correctly and yes they have to give me certified payroll for each employee. If not the contractor does not get paid and I can stop the job and take them to court. I live in New York and what these people get paid is double of the private sector. People should not wonder why it cost so much to do Government contracts and why there taxes are so high and they are going to go up. And Davis-Bacon changes all the time and I have never seen the wage go down.
"There are so many other things you don't know about that drive the price of Government contracts up. I will give you one example, I am putting up a Butler building for the fire department on post it is a two truck garage 40'x40 with a concrete pier foundation no electric, no water, no lights, no heat, no air just a tin building with some concrete. The price tag now sits 450,000 dollars and climbing. If you want more info about Government contracts just say so and I will respond (none of the fireman want this building and they say it is just a waste)." – Paid-up subscriber Mac
"I'm glad to see that my feedback on Gov't wages was helpful. It annoys me when people open their mouths before they do the necessary research especially when broadcasting it to as large an audience as you have. I am just an average 'Joe' with a small six figure portfolio. Since joining the Flex Alliance in the middle of June I've managed to collect $43,000.00 on option sales and a little over $8,000.00 on the short sales of Western Digital and Seagate thanks to the Investment Advisory and Advanced Income. I've adapted these strategies to work with the recommendations in the other Flex publications. It's great to have formed an 'Alliance' with honest, hard working people who are not just out for themselves but want to help the little guy like me. Thanks just doesn't express it." – Paid-up subscriber Paul Wagner
Goldsmith comment: Congratulations, Paul... Those are great returns. Hopefully, your note will inspire others to try the techniques we've been recommending. As I'm sure you experienced, selling options and selling stocks short isn't any more difficult than buying a stock outright. Again, we'd encourage everyone to try it once. Get comfortable with these strategies. You'll be happy you did.
"I just re-read Porter's Friday dissertation on short selling and I must say it was an example of some of Porter's best writing. I just wanted to say that Yes, I have started to do some short selling; yes, I have sold some puts. Not all of your admonitions are falling on deaf ears. I'm really more interested in learning about shorting right now than in long position recommendations. Please keep up the good work." – Paid-up subscriber Jay Rosenthal
"I'm getting tired of all the talk about shorting stocks. The truth is, I wouldn't mind having one or two shorts in my little portfolio; but my online broker won't let me." – Paid-up subscriber Dickmann Boone
Goldsmith comment: Sounds like you need to get a new broker.
"As a subscriber, I take what you say seriously. I have to admit that I have never shorted stocks. I have done covered calls, bought and sold calls and puts, as well as selling puts. Shorting stocks is new to me, and I want to read some publications about it before I do this type of trade. Do you have any suggestions on what publications I can read in doing this type of trade? I don't read or trust any other investment books or publications unless it is recommended by you. I find that you maintain integrity in all of your research and reports that you do." – Paid-up subscriber Steven Buckalew
Goldsmith comment: If you simply want to sell a stock short, I recommend you read Stansberry's Investment Advisory. He's done a great job of hedging his portfolio with strategic short sales (he's been recommending about one short sale a month). You can read last Friday's Digest for a good overview of the shorting activity going on in his portfolio. Of the nine open short positions, Porter's readers are up on eight. Also, read his February 2010 issue, where Porter describes the three different situations he looks for in a short sale. You can learn more about Stansberry's Investment Advisory here.
If you're looking to increase your knowledge of options trading, you can either look into Jeff's Short Report or Doc Eifrig's Retirement Trader. In Retirement Trader, our newest publication, Doc focuses on a short-term trading system that can produce small gains, quickly and safely. He used to work on some of the best proprietary trading desks on Wall Street, including Goldman Sachs. He's using the same strategies the big banks used to make billions to help you produce safe gains in your portfolio. You can learn more about Doc's strategy here.
Regards,
Sean Goldsmith and Porter Stansberry
Baltimore, Maryland
July 26, 2010