The Ignorant Investor

Sometimes it's worthwhile to think about what you really get when you invest your money in a company. I'll use the example of GE, a company in which I have held stock since about 1991, which told the market today what to expect when a new earnings season rolls around early next month:

FAIRFIELD, Conn. (AP) -- General Electric Co. reaffirmed its earnings outlook for the third quarter and the full year on Wednesday, saying the company expects to achieve double-digit percentage profit growth despite the impact of Hurricane Katrina.

The Fairfield-based industrial, media and financial-services conglomerate said it still expects earnings per share of 43-44 cents in the third quarter and $1.80 to $1.83 per share for the year.

So if you had paid $36 for a share of GE in January of this year, what you will see on your investment is net earnings of $1.80, some of which will be returned to you in the form of a cash dividend of 88 cents (according to estimates on Yahoo Finance), and the rest of which will be retained by the company to use as . . . well to use for something. Maybe something like buying another company, introducing a new product line, R&D, or just banked in cash. The key thing is, they'll have ended up with more money at the end of the year than when they started, which is a good sign. A much better omen, in my book, than a loss.

If that 1.80 figure turns out to be right, that means that at a price of $34 a share (which is where it's sitting now), GE is trading at 18 times current earnings. Is that too high a number? Well, it depends on what everyone else who's buying stocks thinks. There's no set P/E ratio for any company. It all depends what everyone else is willing to pay for a share in the company's earnings. GE's 18 is a little higher than average for a huge industrial company in today's market, which means the stock might be trading slightly higher than it should be given GE's not-very-exciting growth rate.

Looking ahead, one way to estimate GE's share price next year is to think about what earnings growth will be, then multiply that by the anticipated P/E ratio. If earnings are up 15% next year and the P/E ratio stays around 18 (not a bad guess), the shares will go up to about $37.25. If earnings drop 15%, the stock will drop to about $27.50. So what everyone would really like to know is: What will GE earn in 2006?

Wish I knew the answer to that one. Me and everyone on Wall Street.