Yesterday, GE reported unexpectedly bad earnings, and its stock dropped more than 12 percent. A couple savvy investors we know emailed us and told us to buy. Jon did a “caveman valuation” and decided that the stock was a good price. He asked me to take money from our emergency fund, put it in my IRA, and invest it in GE.*
I wasn’t so sure if it was a good idea. We have enough in the emergency fund to cover just over three months of expenses. I want to save more–not necessarily six months, but maybe four. Jon thinks three months is fine, since we have two incomes. After all, what are the chances that we’d both be out of work? He thought it would be a bigger mistake to miss an opportunity to invest in GE at a good price. Anyway, he badgered me for several hours until I transferred the money and bought 30 shares of stock, which brought the emergency fund down to just about three months spending money, more or less.
What do you think? Is three months enough for our emergency fund?
*Want more on why Jon thought GE was a good buy?
To see why Jon wanted to buy GE, first check out GE’s dividend, currently 31 cents a share per quarter, or $1.24 a year. We’ll make a 4 percent return just on dividends, even if our stock doesn’t appreciate at all. This assumes GE keeps paying its dividend, which seems pretty likely–it has increased its dividend pretty steadily every year since 1962.
Then look at the adjusted PE ratio. Go to either Yahoo! Finance or Google Finance and search for GE. Divide the current price of the stock by the projected earnings for the current fiscal year (projected earnings are found in the “analyst estimates” section). For GE, it is 32.05/2.25, or 14.2. Now subtract out the dividend yeild, which is 3.87%, and you get an adjusted PE ratio of 10.37.
Then compare this to projected five-year growth, also found under analyst estimates. Using this valuation technique, if projected growth is a lot higher than the PE ratio, the stock is undervalued and a good buy. If the PE ratio is higher, the stock is overvalued. Analysts expect GE to grow 10.96% per year over the next five years, so the stock is basically well-priced.
Keep in mind that these are growth estimates; they could easily be wrong. And this is just a rough guide to value investing; it doesn’t really apply to growth stocks or trendy stocks. Many companies have much higher PE ratios than this formula would suggest. I sold my Chipotle stock at $67, because I thought it was way overvalued. It’s now $110.
Anyway, we decided you can’t go wrong buying GE stock at a reasonable price. Even though the company may be contemplating selling NBC, home to our favorite TV show, 30 Rock.
9 Comments
April 12, 2008 at 6:52 pm
Where is the Chipotle money? Why not use that money? The advice you’re asking has many facets, it’s not just about GE. If you are just starting, it’s risky to put the money into just one stock. Because if you choose Apple, you hit a home run, but Bear Stearns, and you strike out. GE may be more like a mutual fund considering the range of products they are in, but it’s still one stock.
3 months’ may be ok, depending. Are both your jobs pretty secure? Do you have 401(k) accounts, and are you making deposits? There comes a point when the dual-earners 401(k) can give you a loan to bridge a minor issue, if one of you loses your job, the other can take the loan. Here’s an idea to consider: Open a Roth IRA. Put the 3 month’s money in the Roths, in CDs. If you need it, there’s no penalty, if you don’t, it can jump start your retirement savings.
Joe
April 12, 2008 at 8:11 pm
A bit more about the consistency of GE’s dividends.
* Uninterrupted dividend payments since 1899. Two world wars, the Great Depression, the Great Inflation, 18 different presidents–and GE shareholders always got paid.
* Dividend growth averaging 8.9% annually since 1951. For comparison, Consumer Price Index inflation ran at an average of 3.8% per year; nominal U.S. gross domestic product at 6.8%.
The above appeared in a newsletter by Josh Peters, Equity Strategist at Morningstar and author of the Ultimate Dividend Playbook (http://www.morningstar.com/Products/DividendBook.html)
April 12, 2008 at 9:12 pm
Hey, Joe, thanks — We’re definitely diversified. We have a few different mutual funds and bond funds, so most of our money isn’t invested in individual stocks at all. But we figure we’re young enough to take some risks (though GE probably isn’t that much of a risk). We opened our IRAs shortly after selling the Chipotle stock, so now all our investments are through our Roth IRAs and 401(k) accounts.
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February 12, 2009 at 8:12 pm
Great Article. Nice Work.
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