General Electric Stock Upgraded; Investors Promptly Overreact

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Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

After two and a half years of unrelenting negativism, this morning, JPMorgan upgraded General Electric (NYSE: GE) stock. (And there was much rejoicing.)

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JPMorgan has maintained an underweight (i.e., sell) rating on GE stock since mid-2016, reports TheFly.com. And it's been right to do so. Over that time period, General Electric stock has shed more than 75% of its value, falling from north of $31 a share at the end of June 2016 to just $7 and change today.

But this morning, the analyst finally gave GE a break, and upgraded the stock to neutral. Investors responded to the news with enthusiasm, bidding up GE shares by nearly 9% in midday trading. But were they right to do so, or are investors reacting with irrational exuberance over what's really only a lukewarm endorsement from JP?

Let's find out.

What JPMorgan said

With GE down 75% in 30 months, JPMorgan believes that the stock price now finally factors in most of the "known unknown" risks surrounding General Electric. How bad will the insurance losses be? Is GE's massive debt load really as bad as it looks? Which of its assets might the company have to sell off in order to raise cash to pay down that debt, and how badly will this crimp its ability to earn profits farther down the line, after it's sold off its crown jewels?

All of these risks to GE, and more, argues JPMorgan, "are better understood" today. After being "overlooked by most bulls in the past," they're now baked into a much smaller GE stock price, reducing the risk of nasty surprises going forward. "The risk/reward ... is now more balanced in the near term," according to the analyst.

What JPMorgan also said

And yet, consider what stock price JPMorgan thinks is appropriate for GE shares today, even after the upgrade.

Despite upgrading GE to neutral, JP left its price target -- just $6 a share -- unchanged. This means that even at yesterday's closing price of $6.71 per share, the analyst thought GE stock was still a bit overpriced. And now that investors have rushed to buy GE shares on news that JPMorgan likes the stock (which -- allow me to emphasize this point -- it does not really), and pushed GE shares up to $7.30 and more, the logical conclusion is that with its price target of $6 on GE shares unchanged, JPMorgan might very well be forced to downgrade GE stock once again.

After all, thanks to investors' overreaction, GE is now effectively overpriced by more than 20%!

What comes next

The risk that GE stock will sink just as quickly as it rose today gets even greater when you consider the big reveal of JPMorgan's upgrade. In the analyst's estimation, the magnitude of GE's long-term debt load -- $115 billion before netting out $13.5 billion in cash -- means that for the company to effectively trim its debt, it may very well have to conduct a "material equity raise."

Or put more plainly, JP thinks GE is going to sell a lot of stock, and probably soon, diluting the very same investors who rushed to buy GE today -- and almost certainly driving down the share price in the process.

Now, on the plus side, such an "equity raise" would certainly strengthen GE's balance sheet, and help to ensure bankruptcy never becomes a serious risk. It would also, argues JP, create "support" for GE stock at a lower price than what it fetches now. On the other hand, though, it would create support for GE stock at a lower price than what it fetches now.

Or in other words, there's a good reason JPMorgan says it still thinks GE stock is only worth $6.

What it means to investors

This is the reason I fear investors who rushed to buy GE stock today on news of JPMorgan's upgrade are getting it all wrong. There will be a time to buy GE, and a price that is right. But it's not today, and it's not $7.30 a share.

The smarter play here, it seems to me, is to wait for the expected capital raise, wait for GE stock to fall closer to JP's targeted $6 price -- and then buy. Investors who are buying now, I fear, are jumping the gun, and likely to be disappointed with the result.

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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.