General Electric is the Ultimate "Unknowable" Stock

General Electric's largest and most profitable business is GE Capital, its financial arm. This has been true for a decade and is likely to be true into the indefinite future. GE Capital is a huge lender, trader and debt underwriter. Its business is very much akin to Goldman Sachs, Morgan Stanley, Lehman, Bear Stearns, and probably much riskier. The business also has a riskier lending profile than Citibank or Bank of America without the less risky bank deposit and money management revenues that their commercial banking operations bring. It is impossible for an outsider, or a reader of GE's financials to have any idea what GE Capital owns at any given moment, but it is reasonable to assume that it is sitting on tons of subprime mortgage backed securities and tons of other increasingly less valuable collaterialized debt securities that it is unable to trade or make a market in. The banks are getting destroyed for being "unknowable" in these times when credit spreads are widening. The price-earnings ratios are falling to 7 or 8 times current earnings. GE Capital is equally unknowable, yet GE's stock is still trading over 19 times current earnings with a market cap over $400 billion.

I've tried to figure out what else in Jeff Immelt's portfolio might justify such a premium in valuable over other banks. We can instantly rule out the plastics and lighting businesses. These businesses aren't growing dramatically and wouldn't justify at 19 P/e multiple on a stand-alone basis.

Appliances? They make a good oven, but no 19 P/e valuation there. Consumer electronics? I don't think so. Media and entertainment? Not with Rupert Murdoch about to slice the $300 million that CNBC grosses annually to screeds. The water business? A very small part of GE's business, and I can buy Watts Water or another water pure play at 15 times current earnings and with better growth prospect.

Admittedly, the aircraft engine business is good as is the worldwide infrastructure business, but then wouldn't I want to buy Boeing, United Technology, Honeywell or Fluor to play these things at similar multiples. Moreover, GE's has a competitive advantage in these areas through GE Capital's vendor financing of much of their sales. So, a sale can be booked as a sale, but the buyer becomes a debtor to the company. If you think like me that the emerging markets may be the next shoe to fall, then GE Capital vendor financing of these sales becomes a significant liability for the overall company as this sales don't get off the books for years.

For years, GE has argued that that their diversified business model means that the entire business should trade at a premium. I see a bunch of anemic businesses bound into one - none even justifying on a standalone basis a 19 times multiple. Plus, I believe that in the current environment and with the risks that GE Capital provides throughout the company, GE's non-financial business should trade at a discount to their peers. So, I think that the entire unknowable company should be trading at a similar multiple to other institutions that generate most of their business through finance. In other words, GE is dramatically overvalued.

Full disclosure: I am long Boeing, Morgan Stanley and Watts Water and short GE.