The Key to General Electric Company's Future Profits
As General Electric works to simplify its business approach, investors are working to set expectations for a new, industrial-focused era. GE predicts that by 2015 manufacturing will generate 70% of its earnings, up from the mid-60s currently.
For shareholders, that's a good sign. What the market's looking for is reliable growth, heartier margins, and a business model that makes sense for an industrial company. Here's how GE's going to get there.
1 ratio to fixate on
Analyzing a vast conglomerate can pose its challenges for individual investors. Should you focus on international growth, individual business segments, or some other gauge to help predict the future?
Well, in GE's case, there's actually one ratio that's very telling about where this company's headed: the mix of goods sold to services provided. What this reveals is that GE's industrial businesses -- which vary distinctly from GE Capital -- work like a traditional razor-and-blade model. When GE sells a GEnx jet engine, for example, the customer purchasing this complex machinery most likely opts for an ongoing service contract. In total, the exchange represents the initial sale (the "razor" or engine in this case) and the future commitment to purchase services from GE as needed (also referred to as the "blades").
The GEnx jet engine is expected to deliver 15 percent better specific fuel consumption. Source: General Electric.
Gillette, one of the most famous brands in shaving, perfected and popularized this relationship with the customer, and it's become all-too-common in our everyday lives. A company, like the telecom AT&T, will induce customers to sign up for a long-term service agreement by offering them an attractively priced phone on the front-end. The initial sale might generate meager profit margins, but the follow-on sales will more than make up for it.
The key difference between AT&T or GE and Gillette, of course, is that the former benefit from a multi-faceted service relationship rather than one simply providing replacement parts. At GE, follow-up services could include ordinary repairs, optimization to reduce downtime, or simply monitoring of equipment to pre-empt costly wear and tear. These services might entail significant outlays for the customer, but this cost could pale in comparison with the lost sales from a supply chain delay or engine failure.
In the end, services wind up contributing a hefty portion of GE's industrial earnings, even if they're a small slice of the revenue pie. For instance, from 2011 to 2013, services accounted for only 28% of revenue but 40% of earnings on average. That's because operating margins from services are often twice as large as those from the equipment side of the transaction. The sale of equipment is obviously a prerequisite, but it's a one-and-done transaction for the most part. The services relationship could go on for years, which is why services make up 74% of GE's current $244 billion backlog.
Looking to the future, GE is hoping to build an ever-tighter relationship with customers in order to boost attachment rates in the services category. What GE knows and learns about operating its own equipment can ultimately boost efficiency for its end users. GE CEO Jeff Immelt alluded to some of the information-sharing activities that manufacturing customers are clamoring for in a recent post on .
Why the "blades" really matter
As GE Capital's rate of growth falls in-line with the industrial business -- as GE expects it to -- investors' main focus should be on the core manufacturing operations. In this regard, changes in the sales mix between services and goods will be critical to watch.
For many shareholders, the expanding services segment, which will include GE's cutting-edge "industrial Internet" capabilities, holds the key to GE's margin expansion and earnings upside. It's the reason a lot of investors have bought into GE's future, and it just might be GE's most important metric during 2014.
Another number that investors love
Studies show that that dividend-paying companies handily outperform their non-dividend-paying brethren. That's why GE shareholders are so fond of one crucial number: its 3.2% dividend yield. But recognizing that dividends matter is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.
The article The Key to General Electric Company's Future Profits originally appeared on Fool.com.
Isaac Pino, CPA, owns shares of General Electric and LinkedIn. The Motley Fool recommends LinkedIn and owns shares of General Electric and LinkedIn. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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