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General Electric, and the Crumbling Myth of Warren Buffett

By Perry Rod, Published: February 13th, 2009 3:33 PM CST

In December, I did a quick Christmas valuation analysis of General Electric and concluded that $16 was too much to pay for the company, given the current market environment and the company's enterprise multiple.

Since then, GE (GE) has given up tens of billions in market capitalization and just recently bounced off a low of $10.66, a price that has not been seen in over a decade.

Meanwhile, the investment legend Warren Buffett was caught buying into GE when it was trading in the mid 20's.  Of course, when Buffett buys stock he gets extra special incentives.  He received an option to buy 3 billion GE at $22.25 in the next five years and also receives a 10% dividend (callable within three years).  Investors who followed him in, of course, have gotten a rude awakening - and no special incentives.

Warren Buffett has taken a hit, but it is just no comparison to the short term slaughtering of common investors or even hedge funds who mistakenly believed in Warren Buffett's extraordinary leadership position in the stock market.

It's important to note the difference between us and a person like Warren Buffett when it comes to the stock market.  For Warren Buffett, making a billion or losing a billion is meaningless for his day to day life.  A billionaire does not need any more money.  And a billionaire can lose a tremendous amount of money, but is highly unlikely to ever become desperate or in a survival mode.

It may be time for the myth that is Warren Buffett to be shaken.  Buffett’s father was, of course, a Congressman and stock broker.  Little Warren did not grow up struggling financially and had no shortage of connections.  His story is not rags to riches, it is rather upper middle class with many powerful connections – to riches.

That does not mean what he accomplished was not extraordinary.  We know it to be amazing.  He is the richest man on Earth.  But it may be time to take a closer look at these differences between us and Warren Buffett.

It is important to also note that Berkshire Hathaway is a company that is dependent on the Warren Buffett myth: that exaggerated sense of comfort investors share when it comes to Buffett’s beliefs and recommendations.  There is a financial incentive for Berkshire Hathaway to keep the myth alive – that Buffett is an “oracle”.

But the fact of the matter is Buffett strongly suggested to the investment community that they should “buy stocks” and that GE, specifically, was a good investment.  He is a philanthropist, after all.  But GE was not a good investment in the 20’s a few months ago.  That much should be clear by now.

Since Christmas, analyst expectations have dropped to $1.30 and there is high speculation that the $1.24 dividend will be cut (except for Warren Buffett’s shares).  Looking at today’s rough enterprise value analysis, a buyer of $11.50 GE stock would be getting $6 of debt, divided by analyst expectations of $1.30 earnings, leaving a buyer with an approximately 13.5 enterprise multiple, assuming that earnings expectations are accurate.

At this point, with this new valuation, perhaps the stock is a buy.  Even now, however, it might be prudent to wait for the GE board to cut the dividend and free up cash flow.  Also, since GE is no longer providing guidance (except to Warren Buffett?), it may be prudent to wait for a better bargain.  But above all else, it is an important lesson for investors, a reminder that there is a grand distinction between Warren Buffett’s financial decisions and ours.

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