Why GE shares could be a value trap for years to come

Key Points
  • Despite its plummet this week, General Electric shares remain a likely value trap for investors until the company can execute its turnaround plan.
  • A drop of 13 percent still left GE trading at a higher multiple than both the S&P 500 and the industrials sector.
  • Investors were shaken when CEO John Flannery called 2018 a "reset" year, indicating the changes will take a while.
GE CEO John Flannery not surprised by double-digit plunge in stock

Despite its stunning plunge this week, General Electric stock could remain a value trap for several years, until the company can convince investors its ambitious turnaround plan will work.

Shares of the stalwart industrial conglomerate dropped as much as 13 percent after the company announced plans to narrow its business focus, slash its dividend and restructure its board and pay structure.

Given the company's reputation as a reliable income source and a cornerstone of American capitalism, investors might be tempted to dive in after the steep slide in the stock price.

But amid all the moving parts investors had to watch regarding GE, one word stood out: "reset." That's the term CEO John Flannery used to describe 2018, and it's what investors focused on as a reason it might pay to sit on the sidelines for a while.

"The word that jumped out to me more than anything was they called it a 'reset' year," said Burns McKinney, a portfolio manager for dividend value products at Allianz Global Investors. "If you're an investor, obviously when GE is down 40 percent for the year you want to put the bucket under it and and get it at the bottom. But when somebody tells me they're in a reset year, then there's no hurry to get in."

Allianz bailed on GE two years ago when it decided that other companies, like Honeywell and United Technologies, that were growing their dividends and managing their businesses more effectively represented better buys.

An employee of US multinational General Electric (GE) works on a gas turbine at the GE plant in Belfort, eastern France.
Sebastien Bozon | AFP | Getty Images

McKinney said he'll continue to watch GE for a re-entry point, but thinks that could be a few years away.

"Even on the lowered earnings guidance, it's still not terribly cheap," he said. "Turning around GE is going to be like turning around a massive ship. If they're successful at it, they could be another Microsoft. If that's going to be a multi-year turnaround, there's absolutely no reason to be the first ones in."

Indeed, GE cut its guidance to $1 to $1.07 a share from the $1.60 to $1.70 the company had indicated following its second-quarter earnings release. Though it lowered the bar, the company still faces a share price that looks at least fully valued and probably a little overvalued even by standard metrics.

Even after another share plunge Tuesday, the stock still traded at nearly 21 times earnings. That's above the 's 18.4 times P/E and just ahead of the 19.3 P/E that the industrial sector is carrying.

Investors now also have to factor in that dividend cut, which will see the quarterly payout slashed in half to 12 cents a share. The dividend yield will still be considerably above its peers.

Investors looking for signs of when to get back into GE should be watching how the value equation plays out.

"We're value investors, but we do like to incorporate momentum," McKinney said. "We're not trying to bottom-fish. We'd rather be six months too late than six months too early."

GE CEO Flannery told CNBC in a Tuesday interview that he is "not surprised by the investor reaction" as investors had to digest a lot of "tough news."

His investor day presentation Monday also drew some grousing that it wasn't specific enough about the changes.

But Jim Corridore, the director of industrials equity research at CFRA, said he was impressed by Flannery's performance and thinks investors should watch the company closely. That's what CFRA, which has a hold rating on the stock, will be doing as well.

"I'm not seeing a lot of extreme value here, though certainly it's a little more value than it was a couple days ago," Corridore said. "Not only is 2018 a reset year, but 2019 and beyond they're talking about 2 to 4 percent organic growth. That's nothing to get excited about."

WATCH: An analyst give a time frame for when GE could stock could get attractive again.

Cowen analyst: It will take awhile for people to see value in GE