Recently I had a conversation with a friend who told me that he had only inherited General Electric (GE) shares…
Recently I had a conversation with a friend who told me that he had only inherited General Electric (GE) shares that his grandfather had bought several decades ago, and he wanted to know what to do with these shares? Well, I told him I was not an accountant or a pension planner and that I did not know what his tax situation was, but still I would get my Friedrich algorithm to analyze General Electric for him and then let him know.
I would assume there are many readers on Seeking Alpha who experience the same problem, so I decided to put everything in an article to help as many people as I can at once. Now I do not like to write negative articles about stock because I tend to be upset when I read negative articles about the shares I own, but in this case I felt I had no choice, because in the end I would be helping more people than I would hurt by telling them that General Electric is a company with serious problems.
On November 30, 2018, Seeking Alpha’s senior editor Carl Surran reported this “GE price target reduced to $ 7 on Deutsche, dividing 5%”, so I’m not the only analyst who thinks General Electric is in serious problems. In this article, I will not discuss the different operations and how everybody does it because you can read dozens of such articles about searching alpha, both pro and con. What I’m just doing is a quantitative analysis of General Electric’s performance on Main Street and then relating them to what an investor should do on Wall Street, with zero feelings.
When analyzing General Electric, we present some unique conditions that our Friedrich Investing System uses and presents a real-time quantitative analysis that will show the power of free cash flow in the investment process. This way, we will teach everyone how to analyze their portfolio content on Main Street vs. Wall Street. At the same time, we will explain how the methodology contained in this analysis emerged.
Main Street is where General Electric driver and Wall Street is where its shares are trading. The General Electric shares that you can buy on Wall Street are public, and the company has little control over how each stock will trade. General Electric is required to release its quarterly earnings reports every quarter, and from time to time it also gives press releases to its shareholders (and the public) who provide updates on how business is going on Main Street.
Main Street is where General Electric invests in its own business and sells to its customers. How well, General Electric’s Managing Director and its management when selling these products, determine how profitable the company will be. Wall Street then reacts based on success or failure of management to meet its goals. Main Street and Wall Street are thus linked to each other, but because someone with a computer (or even a smart phone), an internet connection and a broker account can buy or sell any stock at any time, skills are not a requirement to invest on wall street.
This results in Wall Street being a very dangerous place to work, as many investors tend to invest through emotions or tend to follow the crew in and out of the shares. Under the bull markets, investors feel that they can not make a mistake like “rising tide raises all boats”. But when a bear market suddenly appears, these same investors tend to panic and like lemmings stamped over the cliff. Thus, we have the classic case of “greed to panic”.
After noticing this problem 30 years ago, I spent an algorithm called Friedrich in the last three decades. Our algorithm was designed to help all investors (both Pro and Novice), enabling them to quickly compare a company’s Main Street business, to its Wall Street valuation (overbought or transferred). Friedrich can do it individually or assist users to analyze an entire index such as S & P 500, ETF, Mutual Fund or individual portfolio using our Portfolio Analyzer. I did it recently when I compared Apple (AAPL) with the S & P 500 Index (SPY) Apple Vs. S & P 500: What is better investment?
Many years ago, I discovered a relationship, as Mr Buffett told owner income, while reading Berkshire Hathaway’s (BRK.A) (BRK.B) 1986 letter to shareholders. “or what we might consider to be Mr. Buffett version of” Free Cash Flow. ” “To my surprise, in the small footnote, Mr. Buffett explains how to use it and basically says that it is one of the key conditions he and Charlie Munger used in the analysis of inventory. In that article, he defined the concept of” ownership income “
“[Owner earnings] represents [A] reported income plus [B] depreciation, deflations, amortization and some other non-cash charges … less [C] the average annual amount of capitalized costs for facilities and equipment, etc. that the business requires to fully maintain its long-term competitiveness and its volume. “
I’ve used this free cash flow ratio for decades, using data from Value Line Investment Survey, whose founder was Arnold Bernhard. Mr. Bernhard was a big fan of free cash flow and probably introduced it earlier than Mr. Buffett did. know this because I could calculate the FCF relationship with old Value Line sheets for my 60 year back test of DJIA from 1950 to 2009.
In the back test mentioned above, I showed that if one can buy a company whose shares sells 15 times or less its price to free cash flow, that the probability of success will increase dramatically in most cases. I have renamed the relationship of the Bernhard Buffett Free Cash Flow relationship to honor both men. The following is how this relationship is calculated.
Price to Bernhard Buffett Free Ka Debt Divisor = Sherlock Debt Divisor / [(net income per share + depreciation per share) + (capital spending per diluted share)]
Sherlock Debt Divisor = Market Price per Share – ((Working Capital – Long-term Debt) / Diluted Equities Outstanding))
The above are the conditions that I use when analyzing a store on Wall Street, and below are the conditions that I use when analyzing a store on Main Street .
FROIC means “Free Cash Flow Return on Invested Capital”
Advance Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) + (Capital Spending)]
FROIC = (Advance Free Cash Flow) / (Long Term Debt) + ownership share)
What the FROIC ratio does is to tell you how much free cash flow generated by the company on Main Street relative to the amount of total capital it has hired. So if a company invests $ 100 total capital on Main Street and generates $ 20 in free cash flow, it has a FROIC of 20%, which we consider to be excellent. This is just one of the key quotas (a total of 66) that we use to identify how a company performs on Main Street because it is our belief that if a company is making a death on Main Street, these news will eventually appear on Wall Streets radar.
So let’s start our analysis while trying to teach everyone how to do a similar analysis on his own portfolio. When analyzing General Electric’s award for the Bernhard Buffett FCF, we must first analyze General Electric’s Sherlock Debt Divisor. Here is a detailed definition of what this relationship is:
A major issue I have today for analyzing companies is how much debt is incurred in relation to the business and if management abuses this situation by taking incur more debt than required. Debt, when used wisely, enables what is called leverage, and leverage can be very beneficial in certain parameters. On the other side of the coin, debt use can also be excessive and put a company’s future at risk. So what I’ve done to determine if a corporate debt policy is beneficial or addictive is to create Sherlock Debt Divisor.
What Divisor does is to punish companies that use the debt unwise and reward those who successfully use the debt as leverage. How do I do this? Well, I take a company’s working capital and subtract the long-term debt. If a company has much more working capital than long-term debt, I reward it and punish those whose long-term liabilities exceed its working capital. So if this result is higher than the current stock price, the leverage effect and the more used a company, the worse the result of this relationship and the less attractive it will be an investment.  Thus, we have successfully defined Sherlock Debt Divisor, we need the following four pieces of financial data to calculate it for General Electric. TTM for those who do not know is “subsequent 12 months” or as close to real-time data as we can get, based on when each company reports.
Market Price per share = $ 7.28
Working capital = Total Total current liabilities = $ 97.060.000.000
Diluted shares Outstanding = 9.208.4 million shares since 2017)
Sherlock Debt Divisor = Market price per share Share – ((Working capital – Long-term debt) / (Diluted outstanding shares))
Sherlock Debt Divisor = $ 7.28 – ((9.224 million – $ 97.060.000.000) / 9.208.400.000))  Sherlock Debt Divisor = $ 7.28 – ($ -9.54) = $ 16.82
Since General Electric has more long-term debt compared to labor capital, we have to punish it and use the new $ 16.82 as our new seller in all our calculations
Price to Bernhard Buffett FCF Ratio = Sherlock Debt Divisor / [(net income per share + depreciation per share) + (capital spending per diluted share)]
Sherlock Debt Divisor = $ 16.82
Net earnings per diluted share = $ -31.239.000.000 / 9.208.400,000 = $ -3.39
Amortization amount per diluted share = $ 6.059.000.000 / 9.208.400.000 = $ 0.65
Capital Expenditure per diluted portion = $ -7.283.000.000 / 9.208.400.000 = $ -0.79
$ – 3.39 + $ 0.65 + ($ – 0.79) = $ -3.53
Price for Bernhard Buffett Free Cash Flow Ratio = $ 16.82 / $ – 3.53 = -4.76
If you go to our FRIEDRICH LEGEND on what is considered a good or bad result) you will notice that our result of -4.76 is considered terrible.
We recently ran our data file for General Electric on December 5, 2018 and our Friedrich Algorithm gave a recommendation to Our subscribers that General Electric is a “Strong Selling” as our Friedrich Data File and Chart below show. There you will also find the last ten years of General Electric’s award to Bernhard Buffett’s Free Cash Flow result.
Now that we’ve learned how we calculate our price for the Bernhard Buffett Free Cash Flow ratio, let’s move on and learn how to calculate our FROIC relationship.
This is how we calculate it:
FROIC means “Free Cash Flow Return on Invested Capital”
Forward Free Cash Flow = [((Net Income + Depreciation) (1+ % Revenue Growth rate)) + (Capital Spending)]
19659048] (Long-term debt + shareholding)
Net profit per diluted share = $ -31.239.000.000 / 9.208.400.000 = $ -3.39
Depreciation per diluted share = $ 6.059.000.000 / 9.208. 400,000 = $ 0.65
Capital Expenditure per diluted portion = $ -7.283.000.000 / 9.208.400.000 = $ -0.79
Revenue development rate TTM = 1%
Shareholder share = $ 31.454.000.000
Diluted shares Outstanding = 9,208, $ 400,000
) [+] $ – 3.51
FROIC = (Additional Cash Flow) / (Long-term Debt + Shareholding)
$ – 3.51 / $ 13.96 = -25%
FROIC = -25%  48] If you go to my FRIEDRICH LEGEND again (if what is considered to be a good or bad result) you will notice that our 25% result is a terrible result and tells General Electric on Main Street to lose $ -25 in Free cash flow for every $ 100 it invests in total capital employed.
On Main Street, General Electric makes awful, but on Wall Street it’s just as bad. If you can build a portfolio by avoiding shares like General Electric and concentrating only on those companies that have excellent Main Street results and buys everything at attractive prices to the Bernhard Buffett Free Cash Flow ratio, then your portfolio must be a star on both Main Street and Wall Street. Finding companies that have excellent results on Main Street and Wall Street (at the same time) are unfortunately like trying to find a needle in a haystack.
Looking forward, if you notice that for the Main Street Prize in our General Electric data file above, we assigned it a result of $ 0. We did this because we have a solid rule that when a company produces a negative result from Bernhard Buffett Free Cash Flow, we automatically get a $ 0 earnings. This is done because we want our subscribers to avoid such investments just like one Private buyers on Main Street would never invest in a company that loses money by hand. If we were to do something with General Electric shares, we would short instead, even at this level, because we see it go much lower. We can say that because the company has a badwill at the price of 118%. Badwill is a relationship that I created that concentrates on the company’s Goodwill + Intangible assets and shows potential manipulation or, in rare cases, fraud from the management. At any time, the ratio is over 100% and Main Street Price is $ 0, it is our Friedrich Investing Systems key to identify a strong card position. Here is the official definition:
BADWILL = Is a way in which Friedrich captures manipulators. When companies make a lot of mergers and acquisitions, they tend to book a lot of Goodwill.
BADWILL = (Goodwill + Intangible assets) / Diluted shares Outstanding.
When Badwill to Price is 33% or higher than the stock price, we generally consider it a bad thing. When it breaks over 100%, it becomes a potential card candidate. In the end, our Friedrich Investment System recommends not only selling General Electric at its current level, but, in fact, it may also be a potentially effective card.
In summary, I believe that free cash flow analysis is the ultimate tool when analyzing companies, and I hope you can add these key figures to your own investor toolbox to assist you in your own due diligence. If you have any questions, please ask them in the comments box below.
Remarks: I am / we are tall AAPL.
I wrote this article myself and expressed my own opinions. I’m not eligible for compensation (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Further information: This analysis is not a recommendation to buy or sell this or any stock it merely refers to an objective observation of unique patterns developed from our research. Actual material is obtained from sources believed to be reliable, but the poster is not responsible for any errors or omissions or for the results of actions taken on the basis of the information herein. Nothing herein should be interpreted as an offer to buy or sell securities or to provide individual investment advice.