With Peter Cohan, a Forbes contributor and author of 12 books including his latest, Disciplined Growth Strategies: Insights from the Growth Trajectories of Successful and Unsuccessful Companies
Steve returns with his guest, Peter Cohan, a Forbes contributor and the author of Disciplined Growth Strategies: Insights from the Growth Trajectories of Successful and Unsuccessful Companies.
In the previous segment, Steve’s conversation with Peter focused on confident executives who practiced intellectual humility, attracted top talent, and charged them with developing new ideas. In this segment, they talk about an erstwhile great, General Electric, which has been in the news lately for sluggish growth and earnings and for failing to convince Wall Street with its recently announced turnaround plan to return to growth.
Singing The Blues At General Electric
Steve begins the discussion with an update on General Electric, which recently cut its dividend in half, prompting him to question what the new CEO has up his sleeve for GE’s turnaround.
Peter adds that the new CEO, John Flannery, is coming in the wake of Jeffrey Immelt, the former CEO, who was there for 16 years but was a bad choice to succeed Jack Welch, GE’s legendary former CEO from 1982-2001. During Immelt’s tenure, GE’s stock fell 40% over 16 years, so the new CEO wants to get all the bad stuff out of the way immediately in order to draw a big line between his predecessor and himself.
$2 Billion Cash Burn
Peter believes Flannery’s first order of business is addressing GE’s $2 billion negative free cash flow problem by cost-cutting and slashing the dividend in half.
Steve reminds his listeners that free cash flow reflects the actual cash being generated by the business and is worse than having negative earnings which often include non-cash items such as depreciation of equipment. While negative earnings are sustainable, negative cash flow is not, so GE will have to slash and burn until they get that cash flow at least stabilized.
Divest Non-Growth Businesses
Peter, author of Disciplined Growth Strategies, says he met with GE’s CFO ten years ago and told him point-blank that GE needed to change the portfolio of businesses it had. Peter recommended that they sell off GE Capital and GE’s media, entertainment, lighting, and appliances businesses, all of which were unattractive because they had no competitive advantage. Peter also recommended that GE invest in aircraft engines and medical equipment to meet growing demand from countries like China and India.
While GE did sell a lot of its businesses, it still did not see a return to growth. Now, Flannery wants to sell off even more of GE’s portfolio, and Peter suggests he focus on businesses where GE has a competitive advantage and can grow market share.
Reinvest In R&D
As a GE shareholder and an analyst, Peter believes the new CEO should get involved in the specific strategies of growth-oriented business units to create new sources of revenue, analogous to Amazon’s Web Services division. For now, Peter is disappointed by GE’s announced “growth” initiatives and plans to wait and see how things shape up. However, since he’s heard good things about their CEO, waiting around may work out well.
Steve says history is rife with companies that, in spite of having had great products and great growth streaks, kept doing the same things over and over and, ultimately, lost out to more creative competitors.
Amazon’s High PE Multiple
In wrapping, Steve reverts to Amazon and its sky-high valuation of about 270 times earnings and asks Peter Cohan, author of Disciplined Growth Strategies: Insights from the Growth Trajectories of Successful and Unsuccessful Companies, if there is a PE multiple for a growth company that he would not pay. In Amazon’s case, Peter says the right metric is revenue growth, not earnings, and when Amazon missed its growth projections in the past, the stock did correct, to which Steve wonders how he’d ever get paid as an investor. Peter says he likely will, in time, when Amazon dominates a lot more businesses than it does today.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: I’m back with my guest, Peter Cohan. He is the author of Disciplined Growth Strategies: Insights from the Growth Trajectories of Successful Companies and Unsuccessful Companies. And today, well right now, for this segment we are going to talk about a company that’s having some problems, as all companies do.
But first let me welcome back Peter Cohan. Hey, Peter, thanks for coming back.
Peter Cohan: Thank you for having me again.
Steve Pomeranz: So, last week, General Electric cut its dividend in half, it was slash in half. What’s going on there and what is the new CEO doing? What is the strategy as you see it?
Peter Cohan: Well, he’s coming on the wake of a CEO who was there for 16 years and was, in my opinion, a bad pick to succeed Jack Welch. During his tenure, the stock fell 40%, over 16 years. And the new CEO came in August 1st, and his idea, I think, is to do what a lot of new CEOs do, which is try to clear the decks and get all the bad stuff out there right away and be able to draw a big line between his predecessor and himself.
Steve Pomeranz: Okay?
Peter Cohan: And I think that’s what they’re doing. And plus, they have a cash flow problem. They have negative free cash flow of about $2 billion, and so they need to get that to become at least flat, if not generate positive cash flow, so they’re doing a lot of cost cutting, including the dividend.
Steve Pomeranz: Yeah, so just for our listener’s sake, it’s one thing to have earnings—and you can kind of lose money on an earnings basis—but earnings can include certain non-cash items, depreciation of your equipment and things like that.
So it’s not necessarily kind of exactly what’s going on cash-wise. But cash flow, with this free cash flow that Peter mentions, is something pretty important to look at because it’s the actual cash that’s being generated. And Peter just said that they’re losing $2 billion, they lost $2 billion last year.
So you can’t continue on like that so they’re going to slash and burn until they get that cash flow at least stabilized. But what do they have to do next?
Peter Cohan: Well, the thing that made GE a great stock between 1982 and 2001, which was the Jack Welch era, was that the company consistently had double-digit earnings growth and always managed to beat expectations by a penny or two. And the stock, if you look at the stock chart during that period, it was just kind of a nice, steady, upward trend and so GE was a growth stock then. And I think the basic reality if it is that GE has to start growing and it’s been growing very slowly. And so why would somebody want to invest in it?
Steve Pomeranz: Yeah.
Peter Cohan: It needs to come up with new industries in which to invest. About ten years ago they invited me down there and I met with the CFO. And, he asked me, point blank, what can we do to get our stock price up?
And I told them that they should change the portfolio business that they have. They should sell off their GE Capital and the media and entertainment and the lighting and the appliances and all these businesses that were unattractive businesses where they didn’t have a competitive advantage. And they should invest in businesses like aircraft engines and medical equipment and businesses that were getting a lot of leaders in markets where there’s a lot of growth and demand from developing countries like China and India.
Steve Pomeranz: Yeah.
Peter Cohan: And they pretty much did that. And the fact of the matter is that it did not contribute to growth. And now one of the things that Flannery’s talking about doing is selling more businesses, and so he’s kind of doing more of the same.
And I think that he needs to figure out how he’s going to get aircraft engines to get a bigger market share; how he’s going to get the other businesses that they want to keep to increase their market share dramatically, in order that the company can boost its revenue growth first.
Steve Pomeranz: Well, I guess he’s got to sell off businesses to raise the cash to do these new things. But how much of that money needs to go into research and development and not go back to buying back the shares of the stock? And well, in this case, they’re definitely not going to increase the dividend.
But what is the catalyst for them here, in terms of their thinking, in order to kind of get out of this, the mired old way of thinking and into the new world?
Peter Cohan: Well, I think the catalyst is to have the CEO start to get involved in the specific business unit strategies of the areas where they want to focus on, figuring out how can they grow in aviation, in power, and in healthcare. I haven’t heard any strategies on how they’re going to do that. Whatever their market share is now, they should aim to double it. And they also need to come up with something like Amazon Web Services. It’s a business that they have a unique ability to do it better than anybody else because of their specific corporate strengths.
So I don’t know what that is, I would like to be able to say that I know what it is. But I think that somebody within GE knows what that is. And they need to create a new business, a new source of revenue, sort of analogous with what Amazon did with the Amazon Web Services.
Steve Pomeranz: So, you’re not too excited about the latest announcements from the new CEO then?
Peter Cohan: There’s nothing to be excited about. I think I would get excited if I could believe that the revenue growth is going to increase. So, I think I’m waiting and I think if you look at what’s happened to the stock I think investors are just disappointed.
Steve Pomeranz: Yeah, I mean it’s been crushed basically.
Peter Cohan: It has been; it’s down dramatically this year. And I am an investor in the company, and part of me is thinking, well, why am I even holding on to this stock? But part of me thinks that they will eventually figure it out.
Steve Pomeranz: Well, a lot of companies get into the mud. I can think of a dozen companies that had great products, great growth streaks—and I’m not saying that management gets lazy, but they keep doing the same thing over and over again, let’ say. They try new things; it doesn’t really work but there is no outside-the-box-type thinking going on.
And then new competitors come in and they basically eat their lunch. So the question is then they kind of throw out the management, bring in new management, and hope for the best. In the case of some companies I can think of, that has worked very well, but these kinds of changes take a long time.
So, let’s say that you’re an owner of GE, right? You’ve owned it at $30 a share, $40-whatever a share, and now it’s $17, $18, $19 a share. I mean you’re kind of buried, but you might say, hey I’m going to wait because they’re not stupid these people, and they’ve got the financial wherewithal to make a turnaround. The question is do you have the patience to wait the number of years it may take?
Peter Cohan: Yes, and I would say I do have the patience and even if they don’t come through, I end up taking a loss. I don’t have such a huge position that it really is going to make any difference.
Steve Pomeranz: Yeah, right, right.
Peter Cohan: But I think it’s a bet that I’m willing to take because I do know one of my family members used to work with the CEO and says he’s very good.
So, I’m hoping that this sort of cutting phase is just the first stage of what will ultimately be getting back to the point where they have cash-flow positive business, so that they can start investing in growth, and they will actually do that. So, I’m hoping they’ll do that.
Steve Pomeranz: Here’s a question for you, the last segment we did, we talked about great growth companies. And one that we mentioned as an example was Amazon.
Peter Cohan: Yes.
Steve Pomeranz: And now we’re talking about kind of the reverse. So let’s talk about the price you pay for stuff like this.
So, Amazon, in 2017, is selling at something like 268 or 270 times earnings. And kind of a typical value investor or someone who likes to buy businesses at a good price—which is an awfully good way to be successful—would say that 270 times earnings is insane.
And they would never pay that and yet the price of Amazon keeps going up and up and up, and I realize that their earnings are growing fast. So earnings are kind of helping to lower the PE over time. My question to you Peter, is there is there a PE multiple for a growth company that you would not pay?
Peter Cohan: Well, I guess in the case of companies like Amazon, I think the PE is the wrong metric. And I think that the right metric is whether they beat revenue growth expectations. Because, in the case of Amazon, Amazon is consistently, it’s always said it’s not going to make money.
It’s investing profits in growth, and so if they can grow faster and beat growth expectations, that’s the right metric; it will go up. And what happens is that every year they miss a quarter and the stock takes a beating. And I’ve been following this for the last several years.
And so, what I found is that’s the time, after it misses, which it usually does and for some reason seems to have done it in the second quarter for the last two years. It does that and the stock takes a beating, and then the next quarter it blows through expectations and it keeps going up. So it seems like that’s, I mean, if you’re trading with stock, that’s one way to look at it. But I definitely think that PE is not the right variable to look at for-
Steve Pomeranz: Okay, but as an investor, how am I going to get my money back? I mean the whole idea of owning a company is that you’re going to get a stream of cash flows as an investor. And you’ll be able to calculate a rate of return on those cash flows based on the price and inflation and other things. But if they’re not earning, they’re not going to make any money; they keep reinvesting back in the business.
I guess I’m just going to have to be very patient and assume that at some point I’m going to start getting some money back.
Peter Cohan: Yeah, I guess what I would say is that investors certainly think that someday. I’ve heard people say this; they think that someday Amazon is going to control so many markets that they’ll finally start to raise prices.
And that’s when all the money will start to flow in.
Steve Pomeranz: I see, I don’t know about that.
Peter Cohan: But I don’t really look at it that way. I mean, I look at it as a company that is the only company on the planet that has reached the scale of 136 billion in revenue in 2016. It’s still growing at over 20% a year.
Steve Pomeranz: Yeah, pretty amazing.
Peter Cohan: And starts growing even faster. And I think what investors look at is beating expectations and raising guidance. And I think if you keep doing that, the stock keeps going up. And as soon as you miss and you lose credibility that you can actually keep doing that, I think people give up on you.
Steve Pomeranz: Yeah, well, it’s the art of investing for sure. My guest is Peter Cohan, his book is Disciplined Growth Strategies: Insights from the Growth Trajectories of Successful and Unsuccessful Companies. And don’t forget, to hear this interview again, to read the transcripts, to read a summary on what we’re doing, you can always go to our website.
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