IFB82: Case Study ($GE) Into Why Investing Principles Are Critical

investing principles

Announcer:                        00:00                     You’re tuned in to the Investing for Beginners podcast. Finally, step by step premium investment guidance for beginners led by Andrew Sather and Dave Ahern to decode industry jargon, silence crippling confusion, and help you overcome emotions by looking at the numbers, your path to financial freedom starts now.

Dave:                                    00:33                     All right. Welcome to this podcast. This is episode 82 tonight. Andrew and I are going to do a case study into a GE. Been in the news recently for some not so great stuff and we’re going to talk a little bit about why investing principles are critical and GE is going to be a great illustration of that. Andrew came across a great article on Wall Street Journal recently and we will put a link to that in the show notes for you guys, but it talks a little bit about a gentleman that worked for GE for a long time and Andrew will give us a little more details on that. So Andrew, why don’t you tell us a little bit about the article.

Andrew:                              01:14                     Sure, yeah. It was actually about several gentlemen, an article was written back earlier this year. There’s this one. He’s like 61 years old. He had basically was able to retire after working at GE for a thing. It was over for the years. He had a pension, 85,000 and you had company stock up more than $280,000, to give some backstory on GE, a huge, huge blue-chip company. I believe the evaluation used to be over $200,000,000,000 back in a, like the.com kind of boom-bust. They kinda had the type of evaluations that you saw just like with every other stock. And same with the financial crisis. However, recently things have been really bad there they went from 2016, they had share price hovering around 25, $30 a share through 2017. It was dropping and I believe by the end of 2017 was around a, it’s around seven a $7 and eighty cents per share.

Andrew:                              02:28                     So the company has just really been struggling and the amount of loss in market value from this stock has just been horrendous. In this Wall Street Journal or the coal, they compare from a dollar standpoint, right? An of market value. Obviously when you compare the accompany like Enron or Lehman that went completely bankrupt, the percentage is not as much because obviously, GE is still alive today, but the actual market value loss was greater than a lot of some of the big name bankruptcy’s or just huge stock crashes that we’ve heard of in the past. Companies like Valiant and Ron DM, Lehman and Bear Sterns. GE has lost more market valued under all of those since 2015, so obviously it had to be a big stock with a lot of the market value at that happen. Really, really a sad, sad story and I think we can shed some light into it and really try to examine it and let’s try to learn lessons from it and hopefully that helps us understand that some things that we like to preach over and over again on the podcast are not just things that we say because they sound nice.

Andrew:                              03:46                     They’re not just things that we say because they’ve been paranoid over and over again, you know, while they might be paranoid, a lot of this conventional investing wisdom really has a lot of weight too. And there’s a reason why people recommend it is because you don’t want to be one of these people who has their financial future really heavily impacted in a negative way because you did not adhere to standard investing principles. You think about like wearing a seatbelt. Right? I remember when I was in high school, I’m, I’m sure this is still true today and I hope it is, there’s a big push to keeping kids from drinking and driving. And so one of the things that they did at my school was they staged like a huge drunk driving kind of a. They basically like make, make the scene where they have like actors and they had some kids from, from the class participate in this, like seeing that they made.

Andrew:                              04:55                     It’s kind of like a play and they just use fake blood and they tried to replicate what a, with a drunk driving scene would look like. And really tried to put you in that perspective as if you were there as if you approached the scene as if these were your friends. So just really illustrate that, you know, this stuff’s dangerous and even though you could drink and drive and be completely fine or you know, you could drive irresponsibly and be completely fine. There are these free cases that happen. And so that’s why we take precautions, you know, why do we wear seatbelts? It’s not because every time you don’t wear a seatbelt, you’re going to die with us because of the worst case. So I think when we talk about the stock market, we talk about investing the whole point of investing, the supposed to be finding a way to put your hard earned money and put that to work for you and continue to work for you. And, while there’s always going to be risk involved, are some ways to use that over. Unfortunately, it’s not always common knowledge for people who are very hardworking and some people end up victims and some really sad stories.

Dave:                                    06:06                     So this story is definitely one of those, as Andrew was saying, is definitely one of the kind of original blue chip stocks and they’ve been around for a long, long time and their decline as of recent is an illustration of what can happen to just about any company out there and you look back at the history of GE and all the things that they’ve been involved in and as long as they’ve been around companies you always thought would just never go away. And whether or not they’re actually going to eventually go bankrupt. You don’t anybody that’s anybody’s guess. But right now it looks pretty dark and it’s also an illustration of what can happen when you put all your eggs in one basket. And that’s one of the things that Andrew and I have talked about many, many times and will continue to talk about it as we go forward with what we try to teach everybody.

Dave:                                    07:08                     Because it’s such an important lesson to avoid. And when you look at all the large investors or any of the superinvestors or the gurus, quite a few of them diversify to a certain extent. And I know Andrew has talked extensively about diversity or diversification before, and I’ll just kind of touch on it a little bit, but the biggest issue with that is making sure that you’re protecting yourself by having more than one egg and went basket. And the gentleman in the article that Andrew was referencing, he had his whole life savings tied up in this one company. Granted he worked for them for 40 years. He had a pension with them, but he also had company stock with them and he never sold it or used that money that he could have used from selling that. Even part of it. Not saying all of it, even half of it or a quarter of it, he could have invested in another company or companies to help him avoid this possibility.

Dave:                                    08:13                     Now I’m sure quite sure that why he was working for the company. He thought this would never ever happen. If you look at a stock chart from 2010 to two, about 2017. It was on a steady, you know, rise going from roughly about a 27 bucks to over $100. And then in the last year or so, it’s dropped to, as Andrew was saying, a little for seven bucks. And why is that? Why has the company fallen on hard times? Well, they haven’t produced and you know, it’s, it’s simply that they just haven’t done a good job. And one of their CEO, Ceos, uh, I think it was Jack Welch, uh, back in the eighties and nineties and early two thousands. He was infamous for every single quarter that they had at least a penny increase in earnings per share. And how did he do that? He manipulated stuff. It was shady and it was not legitimate and they were caught and they were busted by that and it took them a long time to recover.

Dave:                                    09:20                     But they did. And over the last, I think two or three years, they’ve been selling quite a bit of their assets to try to kind of rejuvenate the company. They branched off into a variety of different avenues of trying to create revenue. They basically became a bank for awhile. Uh, there are lending money to people and things of that nature. And that obviously is not their core business. And they got away from that and then they sold those assets actually to Wells Fargo. I know this because that was going on when I worked for them. And so speaking of Wells Fargo, that is something that, you know, in my own personal life, this is an example that I have taken heat of since I worked for the company. I had quite a bit of my 401k tied up in Wells Fargo stock because as a employee when I would get my quarterly shares for working for the company, it was of course always in Wells Fargo stock.

Dave:                                    10:19                     And over the course of the four plus five years that I worked for the bank, I built up a fair amount of money from those stock purchases. And when I graduated so to speak, from working with the bank and left the bank, I slowly started to show a sell those off so that I could reduce my exposure to having so much of my portfolio all in Wells Fargo. And it’s not that I don’t believe in a company, but as this little chart here illustrates that I’m looking at going from $100 to $7, you know, that just makes my heart thud thinking about what would happen to my retirement if that ever happened to me. And this is an example of what you need to do and of diversifying. And this is kind of a cautionary tale and that’s one of the things that Andrew and I like to talk about is show you some case studies or things that could happen.

Dave:                                    11:16                     And this is real life. This isn’t us just making stuff up. This is, you know, these, these things are actually happening to people that are working for these companies. And that’s why it’s so tragic that you see these kinds of things happen to people. And that’s one of the biggest concerns. And that’s why we talk about diversification. So Andrew, I know you’re very well versed in diversification. Would you like to give our kids a little more update on that?

Andrew:                              11:44                     So the thing I’ll say is, you know, you mentioned knowing about GE selling off because you worked at Wells Fargo, but if you are an average investor looking to buy stocks just in general, you can know, you can notice and observe exactly what you’re talking about just by learning some simple skills of knowing how to go to a company’s annual report which is freely available online and looking through those financials and doing like a simple calculation. Something as simple as taking one number and dividing it by the other. And just comparing that to some of the things you hear us talk about on the podcast. So all you have to do is like if you look at [inaudible] balance sheet and you look back over the past 10 years and even more their liabilities, their assets, all of that stuff. It really shrank in the last 10 years. So even though like you mentioned with earnings per share for example, they were able to kind of manipulate it for some time.

Andrew:                              12:53                     And you know, even after the whole scandal that they were still able to make it look decent to where Wall Street wasn’t freaking out. But if you were looking at like actually how many assets do they own, you would see it pretty steadily decreasing. And so just by looking at that and seeing that as an example in 2007, the total assets, if you add everything up, assets, liabilities, equity, uh, they were at almost 800 billion. And now if you fast forward like 10 years, 2017, they were down to like $377 million. So, I mean, I can look at those two numbers and understand quite easily, quite simply that, um, that’s, that’s about losing half of your assets. And so you’ve probably sold off a lot of those just to keep the company afloat. And you can do a simple calculation that to equity. You can see when we talk about, like I talked about a couple of weeks ago about how I would consider a debt to equity.

Andrew:                              13:54                     Anything above like a two and a quarter to be quite high. And um, perhaps dangerous [inaudible] that equity over the past 10 plus years. It’s been over five, around, around four, went down the three, three point eight, and then back up to four point eight in 2017. So we’re really talking about a very, very highly leveraged company. Very risky. Just off one simple rule. If you just take a holistic approach to debt to equity and, and you compare that to some of the findings of the found that it’s quite simple comparison to make, you know, it’s, it’s about double, double more than, than what I tend to like to see. And that’s risky. And then, you know, you can in hindsight, you know, after the fact, once there’s all this panic, then there’s tons of articles online. Even this, this article, the Wall Street Journal a goes in depth about how the pension is really underfunded, how they have so many employees who are owed money on the pension and that the leverage is just too high.

Andrew:                              14:59                     These are all things that you know, you’ll, you’ll hear and you’ll see written about with these companies. They don’t have to hear it. And be so surprised like it caught you by surprise if you’re looking at a balance sheet and doing the simple calculation like that to equity, then you can know exactly where the stock that you own stands and if it’s potentially going to be in that, in that kind of a situation, you know. And like I said that, that, that equity was very, very high for over 10 years. Nothing bad happened with the company. The stock was obviously climbing like they’ve mentioned, but you know, all it takes is a little bit of a, of a stumble, a little bit of hardship. And now all of a sudden all the, all, everything unravels and it all unfolds. And that’s when, you know, things can get really, really rough.

Andrew:                              15:46                     So I think by understanding that when we say, like we mentioned in a previous podcast, we talked about the ESPP, this is a very specific, you know, if I work at a company, I’m getting the company stock, what should I do with that? One of our recommendations was as soon as they let you sell it, you know, take that free discount on the esp and then immediately sell it. And one of those big reasons is exactly for this case, you know, it’s easy to be in a company working there or see a lot of money floating around, a lot of stuff being bought and a lot of money being spent and you can think that, that the corporations fine when in fact you don’t understand the whole picture if you’re not looking at the financials from a macro perspective. So I think that’s why when we say ESPP, that’s really a big reason why it’s a great idea when we say diversify and buy enough stocks to where you’re not relying on any one.


investing principles

Andrew:                              16:41                     I think that’s another obvious one. And it wasn’t just this one gentleman in our, the coal as well. There was another, uh, another gentleman, he said he would use his dividends to buy more GE shares. And so he lost $300,000. I’m after more than 30 years of age, he was able to accumulate shares. We still lost 300,000 because of this, this tumultuous time in, in, in general electric. And um, you know, you got a quote here from, from the founder of National Center for employee ownership. He says, you know, I feel like in retirement diversification is a good thing. He says, employees need to think very carefully about investing their own money beyond 10 percent in company stock. And so, you know, these are all things that hopefully, you know, we don’t turn a blind eye to these accidents. Maybe. Hopefully we, we observe them, we see them and we try to learn from them. And that could be something that potentially changes some of these life down in the field.

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Dave:                                    17:55                     Absolutely. And it’s those things that are so critical to, you know, just being aware of what’s going on around us and making sure that we have a plan and we’ve talked about this just recently, writing down your plan and having it accessible to you such that you can review it every year so that you have an idea of what you’re trying to do and where you’re trying to go. I think a lot of times, just in our general life, we get so distracted by all the different things that are going on in our worlds, whether it’s our family, our kids, you know, our job, our extra curriculars, whatever it may be. And it’s so easy to get distracted and not pay attention and lose focus. And when we’re talking about issues like this, this isn’t something you have to watch every single day. Like, you know, like I do with baseball.

Dave:                                    18:45                     You don’t have to watch a game every single day unless you’re cuckoo like I am. But when we’re coming, we’re talking about the stock market. If you’re, if you’re checking in every six months, you know you’re going to be in the right place to make decisions where you need to make decisions and is not something you need to obsess about constantly, but it’s definitely something that you need to have an eye on and pay attention to. A, I’d never forget, as long as I live. A woman walked into wells Fargo one time and her account was seriously overdrawn and she kept asking me why, why? And as kept telling her no because you don’t have any money. And finally she blinked and looked at me. She said, what do you mean I don’t have any money, I still have checks and the, you know, so she was not aware of what was going on in her account.

Dave:                                    19:39                     She didn’t realize that she was spending more than she was making and she just wasn’t aware. So those are situations that we just have to make sure that we’re on top of and we’re paying attention. So I guess it makes me. Sorry, go ahead. No, no, go ahead. Uh, I was going to say, so a couple of other things I wanted to kind of throw out there about Ge, they’ve been struggling is Jeff Immelt who was the CEO before just recently, kind of between the two financial crisis is that we have had, he went nuts and bought and bought and bought and bought like a kid in a candy store and he spent way more money than they were able to afford and he had to do some things to try to recover from that. And for example, he bought, I think it was seven or eight oil companies during the height of the oil boom.

Dave:                                    20:39                     And then the bottom fell out of the barrel who literally. So oil went from over $100 a barrel to like $40 a barrel in less six months. And so all those companies were huge with that. In 2009 he had to cut the dividend for the first time since the Great Depression. So, I mean, wrap your brain around that. That’s a long time ago. And he had to cut the dividend because he went so nuts buying more than he could afford and like I said, in 2015, he, he divested the GE capital, which I talked about, but the other big issue was a 2016, their core business, which is appliances, that’s what they’re known for. He sold the rights to the GE brand, to a company in China and he did all those things to try to gain more cashflow for the company and it didn’t work and it just was kind of an illustration of what can happen when a company is going crazy.

Dave:                                    21:45                     And like Andrew was saying, taking on so much debt and spending all the free cash flow they have on trying to grow the business and making bad acquisitions or making poorly timed acquisitions. Uh, one of the things that Andrew was, I know is going to talk about here in a second is some buybacks and dividends a, there’s a tweet that he wants to reference. I’m gonna segue over to him for that.

Andrew:                              22:13                     Yeah, sure. I did want to touch on what you said though. I think it’s so key, it really highlights the difference. However, there can be such varying styles of management and I think one can be obviously much better than the others compare CEO, like what he did and what these types of CEOs do, which they do it because it works most of the time until it doesn’t, a lot of times they get their golden parachute and they’re able to leave before it works, but you know, essentially trying to grow the top line or bottom line, uh, really just the top line.

Andrew:                              22:52                     Even just trying to grow that at all costs. Understanding and knowing that like a big part of Wall Street will reward them for that. And there tend to be more people who do that. Then people who are boring and conservative like us and want to look at the balance sheet. They just want to look at the top line. When I, when I say top line, I’m talking about the revenue, just how much money the company is bringing in regardless of how much it’s costing them or how much debt they’re getting into and are those in order to get there. And so that that behavior is rewarded a lot of times and that’s why they can make these poor capital allocation decisions and continue to do it and it doesn’t come back to bite you for many years. And it’s a very obviously short term focus mindset. You compare that to somebody like Warren Buffett who, if you look at the way he acquires businesses for Berkshire, he’s making sure that he’s either getting a ton of cash flow from it or he’s a buying it at a bargain bargain price so he’s not having to spend too much, you know, or combination of both.

Andrew:                              23:57                     And, and so that you can see that he’s able to grow revenue, he’s able to grow earnings, he’s able to grow cashflows without really a taking a huge hit to their balance sheet and it’s because he’s a smart capital allocator and, and he makes those smart decisions. So he still gets the same kind of great growth, but he does it carefully and slowly. And you see that with his emphasis on talking about book value it, they always mentioned it in every Berkshire annual report. What the rapport that book value is, how it’s been growing through the years and how they’re working to increase that. That’s an obvious big, huge kind of focus on the balance sheet and the respect for the importance of the balance sheet and the, how it really reflects on what the health of a business truly is. A philosophy that I, I just wish it was more prevalent and more widespread. You will have less of these kinds of catastrophes when it came to the buybacks. It was just a tweet I saw that I thought was really interesting.

Andrew:                              25:01                     Obviously I like it because it reinforces something that I already believe, but you know, I have this to get into maybe more advanced accounting stuff and stuff we’ve, we’ve talked about in the past, but you know, we’ve talked about share buybacks. I’ll generally they’re good. But if it came to one or the other, I would generally prefer to get a dividend instead of a buyback. And so this tweets was talking about 2016. How Ge spent 21 billion on buybacks when their, when their stock price was at 30 bucks, 2017, GE spent two and a half billion on buybacks when the stock was about $20. And obviously all that’s a lot of that values pretty much been evaporated. So, you know, in summary, the tweet says that’s more than $70 million gone from buybacks over the last two years. Now it’s not to say that, you know, in a situation where you’re receiving a dividend and you’re reinvesting it, you’re losing value with that as well.

Andrew:                              26:05                     But I mean, at least in the case of if you were receiving that dividend, you could have, you could have a theoretically put that money somewhere else, but it’s just to show, you know, another kind of example of that idea of management not really allocating capital in a really great way. I think, you know, when, when they had to cut the dividends and if I look at their income statement, um, because I know Dave, you mentioned one of those years, they cut the dividends. I know for a fact they, they must have covered recently. You said, was it 2015? They cut the, it was 2009. It was 2009 when he cut it the first, the first cut and made it happened again. Yeah. So that was the first cut. That was a whole great depression thing, right? Like they had like a 80 or plus streak and then he cut. Exactly. Yep, exactly. They cut it again recently. I think it was in 2015 or 2016. And those types of cots can really trigger huge stock crashes. You kind of look back with hindsight, but you think, um, would it have been better than just maintain the dividend instead of doing these buybacks, would it, I think, you know, a lot of times it’s better, especially in the case where you’re so highly leveraged, take that cash and pay off some debt, you know, it might not be nice for the share price in the short term.

Andrew:                              27:34                     You see a lot of companies, I know a company I’m invested in right now, investors hate that, right? They hate when you pay off debt. It’s so, so screwy, so counterintuitive, but you know, you take some of that short term hit and over the long term if you can really help the business to say sustainable to stay healthy and to be able to support growth in the future. I think you do that 100 percent of the way. So I guess an example of a time where buybacks maybe can be detrimental when you have a company that’s kind of on shaky footing a, you could be kind of wasting this cash, not allocating it properly. And so I think that just goes to if you can have the skill, and I don’t like what Dave mentioned, you know, every six months or you know, I even like I, I do it every year just whenever the, the annual report comes out.

Andrew:                              28:21                     I have a spreadsheet with all the stocks I own. I have the date the month on there that I need to check these annual parts as they come out and then you just read it and if you see the company going in the wrong direction, you can tell that management’s making bad capital allocation decisions. When you see the debt and the liability is going up and you see the, the assets are shareholders equity going down and if you see earnings either stagnant or decreasing, uh, those are all things when, when put together a signal, a company that’s in the management that’s not make, not doing good things with their money or their business model is not doing very, very well. And so when it happens at a large scale and it’s really, really something more than, than just a small kind of hiccup in the numbers are, are natural kind of volatility in the numbers. When you see a big moves like that, whether it’s because of a bad business model or because of bad capital allocation decisions, why would you want to stay invested in that? Those are the things you want to look for. And if you can, if that all make sense, if you can find the patients to, to look at it, look at the balance sheet and say, here’s our assets. Here’s liabilities. Here’s equity. One, two, three, one plus the other equals the other. And then you can make these observations for yourself. It’s not rocket.

Dave:                                    29:43                     No, and I think the. It’s not rocket science and I think you’re idea about working at capital allocation is so spot on and right on the money and when you’re talking about buybacks, the

Dave:                                    30:04                     The craze right now is is buybacks and we, we talked about that recently. We’re talking about the shareholder yield that Meb Faber is a big fan of and buybacks can be very beneficial to the company, but only if they’re buying a back at a price. That makes sense. So if the company is continually falling in valuing and the share price keeps falling and falling and falling and a company he was buying back its own stock and it doesn’t rebound and it just keeps going down. Then you’re losing any sort of value. You have an accompany and so it can really kind of by, but. And so finding good capital allocators is one of the, I guess big pieces when you’re looking at management and trying to determine whether these are good managers or not. And I think that’s one of the things that Buffet and Munger both are huge proponents of is finding people that are great managers and great allocators of the capital that they generate from their companies because they understand that a great manager is going to be able to take whatever money he’s making and use that to either grow the company or to give I do, I guess give back to the shareholders.

Dave:                                    31:24                     So by increasing their value and they understand who they’re really working for, they’re really working for us to investors when you’re a public company like that. Really they’re working for us because we’re the people that are putting money into the company to try to help them generate more money for us. And if the manager is really out for himself and is looking at the buybacks, for example, as a way to increase his earnings per share, which is going to increase maybe his compensation share wise that he may get or she then it could be detrimental to the company in the long run. And like Andrew was talking about with the golden parachute, you know those people are so reviled and you see this time and time again where the bad managers go into a situation and they used the company as a way to create more wealth of themselves out of selfishness and it ends up hurting us and it creates so much bad vibe and bad blood and turns people off from investing.

Dave:                                    32:34                     Which in the long run is is even more detrimental than losing a few dollars here or there. And that’s what’s so criminal about that. And that’s why finding good allocators of capital is so critical. And having these investing principles that Andrew and I’ve talked about, time and time again are going to come back and help you so much as you go along and your journey of trying to invest. And that’s really what the game is all about is you know, having a plan and understanding what it is you’re trying to do and making sure you stick to that plan. And all these things that we’re talking about is our methods and ways to make sure that you’re paying attention enough that you do not lose your capital. As our buddy, uncle Warren says all the time. Rule number one, don’t lose money. Rule number two, don’t forget rule number one.

Dave:                                    33:25                     So that’s what this is all about is when you put the harder money in there, you want to make sure that when you go to take it out, equal be there. So that’s what we’re trying to do. Yeah. It’s really, it comes down to just short term focus versus longterm focus, right? Yeah. Yeah. See that managements and. Yep. It’s no coincidence that buffet successful because he’s been around for 50 years. No coincidence he has been around for 50 years because he’s successful. It’s a very long term focus and I think we all need to be the same way to.

Dave:                                    33:56                     All right folks, we’ll that is going to wrap up our discussion for this evening. I hope you enjoyed our little discussion on the case study of GE and why having invested in principles are so critical and how they can help you grow your wealth and preserve your wealth as you get closer to retirement. So without any further ado, you guys go out there and have a great week. We’re recording this during thanksgiving, so those of you in the United States have a great thanksgiving weekend. We hope you have fun with your families, enjoy a lot of Turkey and pumpkin pie and go out there and invest with a margin of safety. Emphasis on the safety, and I’ll talk to you guys next week.

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