3 Key Takeaways From General Electric's Q2 Earnings

By Markets Fool.com

Getting to the bottom of GE's earnings report takes some digging. Image source: Getty Images.

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In the two weeks sinceGeneral Electric(NYSE: GE) announced its second-quarter earnings on July 22, the stock price has been sliding steadily downward. Just before the announcement, on July 19, it hit a one-year high of almost $33 a share. But it's dropped 5.5% since and is now sitting just above $31 a share.

You'd think such a prolonged slide was triggered by a lackluster earnings report. But at least on the face of it, the numbers looked good. Here are three key takeaways from the report -- and the reaction that followed.

The big numbers

Earnings and revenue were both up compared with Q2 2015 -- way up, in fact. In 2015, GE's second-quarter earnings per share were $0.31 on $29.3 billion in revenue. This year, Q2 EPS was $0.51, a 65% increase, on $33.5 billion in revenue, a 14.3% increase. That's the biggest gain in YOY quarterly profits for the company in more than five years. Impressive numbers, made even more impressive by the weak macroeconomic environment in which they occurred.

With a manufacturer like GE, it's important for investors to keep an eye on the backlog to make sure it's growing -- or at least, not shrinking. This quarter, the company's total backlog -- equipment and services -- reached an all-time high of $320 billion, up 17% YOY.

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Even big earnings, revenue, and backlog increases can lead to a stock sell-off if they don't match analysts' expectations. But these numbers handily beat the Thomson Reuters consensus EPS estimate of $0.46 on $31.8 billion in revenue. In light of this, the stock's prolonged slide might seem baffling, but let's dig deeper.

Scratching the surface

The big numbers make simple comparisons between the prior and current year. However, GE's operations are anything but simple right now. The company is absorbing its largest-ever industrial acquisition of Alstom Power, which closed in November 2015 (between Q2 2015 and Q2 2016). The company is also rapidly divesting many of its GE Capital financial businesses, much of which also occurred between the two quarters. As a result, the big numbers aren't as impressive as they seem.

Take GE's quarterly industrial revenue, for example. Its GAAP number is $30.6 billion, which is 15.1% higher than the prior year. But after GE backs out a loss of $600 million from GE Capital, since it doesn't count that as "industrial," and then takes away $3.1 billion in restructuring gains and $3.2 billion in Alstom revenue, it only reports "adjusted" industrial revenues of $24.9 billion, which is down 5.7% from the prior year.

Similarly, quarterly EPS was affected by company buybacks of $13.7 billion in shares so far this year. The sale of GE's appliances unit also was completed during the quarter, inflating EPS by $0.20.

The company's order numbers for the quarter also present a mixed picture. As I mentioned, the company's total backlog was up 17% YOY. But if you don't count the orders "inherited" through the Alstom acquisition, the backlog rose only 6%. And overall industrial orders decreased 2% YOY to $26.6 billion. On the whole, this is good news, since it shows that the company has room to absorb further order declines without a negative impact on the backlog. But it's not the unmitigated success that the backlog number implies.

Power's on, but the gas is out

General Electric is a very diverse company, the fate of which rests on the success (or failure) of its component businesses. Looking at how those businesses stacked up individually can provide additional context to the company's overall numbers. Luckily for GE, its three largest divisions turned in the strongest performances this quarter.

The company's largest division, power, saw the largest YOY quarterly revenue increase, at 31%. Profits were also up, but only by 9%. But a lot of those increases were due to the Alstom Power acquisition. Other bright spots for the company included the second and third largest divisions by revenue: aviation and healthcare, respectively. Revenue in both divisions increased by 4% YOY, while aviation profit rose 6% and healthcare profit was up 11%. These wins were needed, though, to offset weakness in other areas.

Appliances and lighting, at first glance, seem to have had an astonishingly rough quarter, with revenue down 25% and profit down 42%. However, remember that GE completed the sale of the appliances portion of this division in early June, which means that nearly a month of appliances revenue is missing from the comparison.Even factoring that in, the lighting portion still underperformed.

Meanwhile, GE's oil and gas segment continues to be the biggest thorn in the company's side. Q2 revenue in the segment, which was the company's third largest in 2014, sank by 22% YOY, the worst performance of the company outside of appliances and lighting. Oil and gas profits fell by 48% as weak fuel prices continued to put a drain on the business. GE continues to hope that a turnaround in energy prices is imminent, but until then, this unit is going to be a major drag on the company's bottom line.

Foolish takeaway

It's not a good idea to stop at the big numbers such as EPS, revenue, and backlog growth in an earnings report. While those can give you a broad snapshot of how a company's doing, they can also paint too rosy a picture. Such is the case with GE. However, don't discount the big numbers, either. Even though the company's growth wasn't awe-inspiring, for a company that's in the midst of a major restructuring and refocusing in an uncertain economic climate, the company's performance this quarter was solid, albeit not stellar.

GE's future success hinges on its ability to maintain its strong brand and reputation as it transitions into the digital age of industry.But just like cleaning up a messy room, it may start to look worse before it starts to look better. For the next several quarters, investors can expect to have to really dig to understand the company's numbers.

All that said, a slide of more than 5% seems unwarranted. If you've been thinking of adding GE to your portfolio, now might be a good time to pull the trigger.

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John Bromels has no position in any stocks mentioned. The Motley Fool owns shares of General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.