GE (NYSE:GE) Has a Depressing Return on Capital Despite Improving Bottom Line

Stjepan Kalinic
July 31, 2021
Source: Shutterstock

General Electric NYSE:GE ) scored a positive week (climbing as high as 6.5%) after an earnings surprise.

With the free cash flow guidance moving to US$3.5b-5b from the previous $2.5-4.5b. Current analyst consensus is growing bullish, with nobody rating the stock a sell .

Yet, return on capital employed, which we will examine today, remains depressingly low.

Reverse Stock Split is Here

As of yesterday's market close, the stock has reverse split 1-for-8, meaning that shares that closed at $12.95 yesterday will trade at $103.6 at Monday open, with 8 shares combining into 1.

The company authorized this move back in June , quoting business reorganization over the last years (including exit from most financial business operations) without reducing the share count.

After decades of expansion into non-core ventures like insurance and other financial operations, GE decided to focus on 4 core segments: healthcare, aviation, power, and renewable energy. On top of that, the company announced a goal of net-zero emissions by 2050 .

GE 0 emissions plan, Source: Future of energy white paper

This move will bring the share count more in line with competitors. For example, Siemens AG has 1.635b shares outstanding, while GE has 8.78b.

Although a reverse stock split doesn't change anything fundamentally, it can still have psychological impacts. After all, GE stock used to trade as high as $57, over 20 years ago, before steadily crashing down as low as $5.5.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business.To calculate this metric for General Electric, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.0049 = US$889m ÷ (US$238b - US$57b) (Based on the trailing twelve months to June 2021).

So, General Electric has a ROCE of 0.5%. Ultimately, that's a low return, and it under-performs the Industrials industry average of 8.7%.

Check out our latest analysis for General Electric

NYSE:GE Return on Capital Employed July 31st, 2021

Above you can see how the current ROCE for General Electric compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering General Electric here for free.

How Are Returns Trending?

The trend of ROCE at General Electric is showing signs of weakness.To be more specific, today's ROCE was 2.9% five years ago but has since fallen to 0.5%.What's equally concerning is that the amount of capital deployed in the business has shrunk by 43% over that period.The fact that both are shrinking is an indication that the business is going through some tough times.Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term because, statistically speaking, they've already gone through the growth phase of their life cycle.

Our Take On General Electric's ROCE

In short, lower returns and decreasing amounts of capital employed in the business don't fill us with confidence.Long-term shareholders who've owned the stock over the last five years have experienced a 53% depreciation in their investment, so it appears the market might not like these trends either.

That being the case, even with the underlying trends improving to a more positive trajectory, it is still not enough to mandate unreasonable optimism regarding the stock.

If you're still interested in General Electric, it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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