Image source: GE.
Big = safe, and small = risky. At least, that's what conventional investing wisdom would tell you. But does that wisdom hold up in practice?
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Take, for example, General Electric . There's no question that the company is big. For a company as large as GE, though, its risk disclosure in the 10-k is surprisingly short, and most of the risks listed dealt exclusively with its soon to be divested GE Capital. That said, two big risks stood out, but there is a third that wasn't mentioned investors should be mindful of.
Risk No. 1In GE's legalese: "Intellectual property -- Our intellectual property portfolio may not prevent competitors from independently developing products and services similar to or duplicative to ours."
In plain English: We've got competition.
GE has some big -- and I do mean big -- advantages over its competitors, the first of which is its size. It's much larger than any other industrial conglomerate out there; dwarfing next-largest German competitor Siemensby more than $50 billion in annual sales. Its size gives it the resources to spend big money on research and development of its "intellectual property portfolio," meaning its patented inventions.
However, just as the race doesn't always go to the swift, nor the battle to the strong, the best inventions don't always come to those who spend the most money. GE has invested millions of dollars in industrial batteries but recently had to scale back production, citing longevity concerns.At the same time, the much-smaller Tesla Motors has announced more than $1 billion in reservations for its PowerPack and PowerWall battery systems, which will begin production next year.
However, even if a smaller-but-luckier competitor like Tesla happens to stumble across an innovation that makes one of GE's major product lines obsolete -- a more efficient locomotive, for example -- it wouldn't necessarily spell doom for GE. GE's reputation and brand still hold a great deal of clout and could persuade customers to stick with its products, even if they were slightly less optimal. It would, however, likely impact GE's bottom line. The problem is, investors won't know a competing product is coming until it's announced, and by then, it will be too late.
Risk No. 2In GE's legalese: "Regulatory -- We are subject to a wide variety of laws, regulations, and government policies that may change in significant ways."
In plain English: Politics is a fickle game.
As a large multinational company, GE is subject to a lot of laws and regulations, both domestically and abroad. These run the gamut from employment and labor standards to financial services and international commerce rules. Moreover, all are subject to change based on the prevailing political environment.
One good example of this risk in action is Congress' recent failure to reauthorize the Export-Import Bank, which underwrites loans to foreign purchasers who buy American goods.Many U.S. companies said the Bank was necessary to "level the playing field" between them and their foreign counterpartsCongress disagreed, however, seeing it as "corporate welfare.".
With the lapse of the Bank's authority, GE has had to find alternate financing arrangements for an estimated $11 billion worth of projects on which it is bidding. The company also plans to move hundreds of jobs overseas to plants in countries where financing can be found.
This reflects how much of an impact government policy can have on GE's operations. Unfortunately for shareholders, there isn't much of a way to know what regulations or laws might be coming down the pike until they come up for debate in Congress, or are enacted by a federal agency. Even then, court challenges or shifts in the political landscape can put things in limbo.
In my opinion, the best course for a patient investor is to ignore potential regulatory or legal burdens unless they have the potential to materially affect one's investing thesis about a company...which most won't.
Risk No. 3:In GE's legalese: Not mentioned
In plain English: That PR Disaster that no one sees coming
There's one massive risk I see to investing in GE that isn't listed on its 10-K: a PR nightmare on the scale ofVolkswagen'sdiesel emissions scandal.
As the great Warren Buffett once said, "It takes 20 years to build a reputation and five minutes to ruin it." Certainly, VW is experiencing this firsthand as a result of its fraudulent diesel emissions software.But even companies that weren't committing fraud have found themselves in a reputation-killing situation. ThinkToyota's"unintended acceleration" issue from 2009 orBP'sDeepwater Horizons debacle. Toyota's stock took nearly a year to bounce back, and BP's has never fully recovered.
The forms that such an incident could take are endless, but for GE, it could be a very public disaster: think a faulty GE locomotive or aircraft engine, for example. Such a catastrophe could result not only in customers' loss of confidence in GE's brand, but also litigation or settlement costs that would affect the company's bottom line.
Like the other risks I've mentioned, though, there's no way to see something like this coming before it actually occurs. And even if it comes to pass, there's no telling how bad the fallout will be. Fortunately, the likelihood of a major PR debacle occurring for any given company is low -- at least the ones we can see.
Lower risk, lower reward?All things considered, I don't think any of these risks are anything GE shareholders should lose sleep over. Massive PR debacles that permanently affect a company's bottom line are rare, and there's no reason to believe that GE is any likelier than any other industrial conglomerate to have one. Similarly, disruptive innovations that can kill entire product lines are uncommon. Finally, political changes are all too common, but are just as likely to affect GE's competitors. Overall, I believe the risks to investing in GE are very low.
However, as low-risk as GE is, investors who want to accumulate market-beating returns should consider carefully how much capital they want to allocate to such a large, stable company. The stock will give their portfolio some stability, and pays a nice dividend to boot. However, bigger potential gains are probably located elsewhere...along with bigger risks.
That said, I think GE is an excellent investment for investors seeking lower-risk returns.
The article The 3 Biggest Risks to Investing in General Electric originally appeared on Fool.com.
John Bromels owns shares of BP p.l.c. (ADR) and Tesla Motors. The Motley Fool owns shares of and recommends Tesla Motors. The Motley Fool owns shares of General Electric Company. 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.
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