General Electric (GE +1.51%) has been a tough stock to love since the deep 2007-2009 recession. After a lot of upheaval, management appears to be working on a turnaround, but there are still a lot of unknowns. The bearish take on GE by the researcher who called out Bernie Madoff's Ponzi scheme made that very clear. Here's the big picture you need to think about before you consider buying GE stock.
A swift and massive drop
GE's stock plunged by more than 10% when Harry Markopolos' negative report on the company hit the market. It's OK if you don't know who Markopolos is -- he isn't exactly a household name. However, he did contact authorities about the massive Madoff Ponzi scheme before that mess erupted into the public eye. That gives him, and his skill as a forensic accountant, a fair amount of credibility. And that isn't his only claim to fame, just his most newsworthy success.
Image source: Getty Images.
Right now Markopolos is calling GE "a bigger fraud than Enron," a claim prominently displayed on the website he created to distribute his research. His main complaints are that GE hasn't reserved enough for its insurance liabilities and that the company should handle its ownership stake in Baker Hughes, a GE Company differently. Markopolos makes other claims, as well, which you can read all about in the 175-page report he has made available at the website linked above. However, you don't need all the details to understand the big issue for investors: risk.
The fact that the stock dropped so dramatically on this news shows that investors are still very worried about GE's future. CEO Lawrence Culp helped to quell concerns by stepping in and buying shares of the company he heads. He also spoke out strongly, calling the accusations market manipulation. Markopolos is, for reference, working with a short-seller (short sellers benefit when stocks fall in value). Notably, Wall Street analysts also jumped into the fray to defend the company.
What do you do?
Looking more like a soap opera than an investment, the biggest problem here is that, for most investors, there's really no way to tell if Markopolos' claims have any merit. And there's also no way to tell if Culp's claims about Markopolos' claims have any veracity. The only thing that is clear is that General Electric is struggling through a difficult turnaround. And that's not new.
The problems started well before the 2007-2009 recession, when Jack Welch allowed GE's financial arm to grow far beyond its main purpose (helping customers to buy GE products). With its fingers in everything from mortgages to insurance, the recession forced GE to write down the value of assets, take a government handout, cut its dividend, and start a major overhaul of its business. That process was, based on the comments from CEO Jeffery Immelt at the time, going OK until the board ousted him in 2017.
Handing insider John Flannery the reins, the company announced write-offs, a dividend cut, and plans for asset sales. Things were not, perhaps, going as well as investors had been led to believe. And one of the big problems was, once again, troubles within the company's finance division. But Flannery only lasted a year or so in the top spot, replaced himself in late 2018 by outsider Culp. Culp announced write-offs, asset sales, and brought the dividend down to a token $0.04 a year (just enough so that institutional investors with a dividend mandate could continue to own the shares). The finance arm was again a key issue, as was continued difficulties in a few of GE's industrial businesses. The big story, however, was that turnaround attempt No. 2 wasn't going well.
Far from simply rehashing an old story, the point here is to show that Markopolos is hitting on themes that have been a concern for some time now. In fact, the Securities and Exchange Commission (SEC) is investigating GE for its accounting practices. So these claims aren't coming from out of the blue. There are a lot of unknowns for investors as GE looks to turn its business around. And, perhaps most important, there's really no way for most investors to figure out what's really going on. Investing in General Electric today is an act of faith.
Fraud or not, GE isn't worth the risk
At the end of the day, GE is at best a risky turnaround stock. There's no way for most investors to tell if the current fraud claims are legit or not. And while the low stock price suggests there's material upside potential if GE can get its house in order, the risk that the turnaround doesn't work out (for the third time) shouldn't be ignored. Unless you have a strong stomach and material conviction that this turnaround attempt is different from the last two, most investors should avoid GE today. There are simply too many things that investors just don't -- and can't -- know.
