General Electric Stock Upgraded: Why 1 Analyst Doesn't Hate It Anymore

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...

It was one of the most backwards compliments I've seen on Wall Street in months, I'll admit. But nonetheless, on Thursday, Standpoint Research nonetheless upgraded General Electric (NYSE: GE) stock to neutral.

Mind you, Standpoint assigned GE stock a $24 price target, which is still $4 below what the stock costs today. Ordinarily, you'd think that would be a reason to sell the stock, but Standpoint no longer believes that's true. Here are three reasons why.

1. Not much to like about GE

Let's start with the bad news: Standpoint Research does not like General Electric stock -- not one bit. As analyst Ronnie Moas wrote in his report yesterday, GE:

• has "a low cash position,"
• its debt levels are "high,"
• and despite getting a lot cheaper over the past year, the stock still costs a lot -- boasting a "235 billion dollar market cap."

2. Truth in numbers

And all of this is true. Turning to financial data superstore S&P Global Market Intelligence for some numbers, we find less than $7.9 billion in cash and equivalents remaining on GE's balance sheet as of the end of Q1 -- down $2.65 billion from just three months ago, and 15% below year-ago levels of cash reserves.

As far as debt goes, Standpoint is right about the company carrying a lot of it. But to give credit where credit is due, GE's $99.7 billion in long-term debt is down significantly from the $105.1 billion that it owed at the end of last year. What's more, GE has cut its debt load by 25% over the past year -- both remarkable achievements, and supportive of Standpoint's more optimistic (or at least less pessimistic) rating on GE stock.

It's also worth pointing out that, whatever you think of GE's balance sheet, the company's market cap of $235 billion is a lot less challenging than it once was. Since Standpoint first rated GE a sell one year ago, the stock has underperformed the S&P 500 by "3000 basis points" (30 percentage points). As the S&P 500 grew 16%, GE stock went in the other direction, falling 14%.

3. Not an entirely "mean" note

A confirmed fan of "mean reversion" investing, it's this last point that really grabs Standpoint's interest. "[G]iven the recent relative and absolute under-performance," argues Standpoint, the analyst can no longer assign GE its "lowest recommendation " -- a sell recommendation. GE stock may remain overvalued, but it's not so glaringly, obviously overvalued as it once was. In fact, says Standpoint, GE is so close to fair value right now that one single market "correction" of only moderate size would be enough to pull GE stock down to its fair value of $24 a share.

The upshot for investors: Valuing GE

Is Standpoint right about that? The math certainly works. If you define a market correction as stocks falling roughly 10% in price, then subtracting 10% from GE's current share price of $27 would knock the stock down to $24 and change -- within easy spitting distance of Standpoint's target price.

What's harder to gauge is whether even $24 is a low enough price to capture what GE stock is really worth. After all, at today's $27 share price, GE stock is still selling for 27.5 times earnings. That seems pricey given that analysts polled by S&P Global don't see the stock growing earnings at anything more than 11% annually over the next five years.

Even more disturbing is the fact that GE hasn't generated any free cash flow at all for more than a year -- instead burning $7.7 billion worth of cash over the past 12 months, even as it reported GAAP "profits" of more than $9.2 billion.

To my Foolish eye, that's a nearly $17 billion disconnect between what investors think General Electric is earning, and what its cash earnings really are. And it's a great reason to remain bearish on GE -- and keep on selling GE stock.

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Rich Smith has no position in any stocks mentioned. The Motley Fool owns shares of General Electric. The Motley Fool has a disclosure policy.