The Ignorant Investor

I can't help but talk about General Electric's earnings again. Earnings are to the stock market what marble countertops, stainless steel appliances and family rooms with high-ceilings are to the housing market. Forget about all the happy talk about how a company does great things for the community, how they're bright and innovative there, how the workers love management. What the stock market is thinking about is how much money the company is going to make. Making money is, after all, what companies are supposed to do. It's the reason they exist. In fact, it's the only reason they exist, and it isn't possible to understand the stock market without understanding just how much earnings reports and estimates drive a company's stock price.

For GE, according to information available at Stockselector.com, here's was the company earned in each of the last nine years on a per share basis:


1996- $ .73
1997- $ .83
1998- $ .95
1999- $1.09
2000- $1.29
2001- $1.38
2002- $1.64
2003- $1.76
2004- $1.96

Put that in the category of what we know happened. We also know that in the first six months of 2005, the company reported earnings of $.82. All of this information as been "priced into" the stock, that is, traders have used the information to decide what price they'd be willing use in buying or selling a share of GE. Since all these earnings have come and gone, they're far less important to the investor than these estimates of future earnings:

2005- 1.82 (est.)
2006- 2.06 (est.)
2007- 2.29 (est.)

Notice that Wall Street now expects GE to do a little worse this year than it did last year, but to then bounce back in 2006 and surpass it's 2004 earnings by about 5%. Because GE is a multi-faceted company broadly involved in many sectors of the company, I'd argue that it's not a bad surrogate for how Wall Street perceives the economy right now. Despite some voices out there in bloggerville and CNBC arguing that the economy will run out of steam in 2006, the estimates indicate that Wall Street as a whole sees 2006 as more of the same: slow, unexciting steady growth.

Also note that the company increased earnings at a varying rate during the booming 1990s, but rarely grew earnings by more than 15%. For a while during the late 1990s the share price grew faster than 15% a year, but it later slowed to a more pedestrian rate and now basically is treading water. To me, that slowing indicates that while a share price might soar above its earnings growth rate for certain periods, eventually it stops to let earnings catch up over the long term.

Funny thing is, even if the 2007 estimate turns out to be accurate, we still don't know what GE shares will cost then. P/E ratios vary by the mood of the market, and what the share will cost will depend on what multiple the market is placing on large industrial stocks in 2007. Will it be 10? Will it be 25? Nobody knows. But assuming that GE's p/e ratio is somewhere within that range in 2007, on earnings of 2.29 the share price could be as low as around $23 (a 30% or so drop from today's price) or about $57 (a 60% rise). All depending on the mood of investors.