What GE's Miss Says About the Economy

General Electric's earnings bomb rocked the market April 11, leading to a drop of 257 points, or 2%, in the Dow Jones industrial average and evoking shock and indignation from analysts.

Oh, the duplicity. GE (symbol GE) had given no warning that profits would be dropping, leaving analysts' intricately constructed models smashed and their pants down. But Wall Street histrionics aside, GE's fleeting fall from grace is a reality check on what's working and what's not in the economy.

GE is the ideal coal-mine canary for the economy. It makes jet engines, water filtration plants, home appliances, medical equipment, TV shows and motion pictures. It also has big interests in financial services, among many other things.

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So, with the economy still reeling from a credit crisis, where did GE sneeze? Where you might expect: Financial services. The company says it couldn't complete asset sales because buyers didn't have the money, and it wrote down the value of investments it owns.

GE's first quarter earnings missed analysts' expectations by 7 cents per share, 5 of which came from problems in the financial-services business (in case you think a 7-cent shortfall is chump change, it represents roughly $700 million).

GE said its net income fell 6%, to $4.3 billion, or 43 cents a share, from $4.57 billion a year ago. Further, it lowered its 2008 forecast for earnings from continuing operations from $2.42 per share to between $2.20 and $2.30, to accommodate an estimated 5% to 10% decline in financial-services profits.

Why hadn't GE warned everyone beforehand? Chief executive Jeff Immelt said the company was caught off guard by the "the extraordinary disruption in the capital markets in March."

The company saw its stock price fall $4.70 on April 11, to $32.05. The plunge sliced $47 billion off of GE's market capitalization. But considering that the company dropped its earnings guidance by 9% and that the market often overreacts to negative surprises, a 13% drop in the share price seems a fair penalty (considering what happens to disappointers, you could argue that GE shareholders got off relatively easy).

The size of the stock's decline seems downright modest when stacked against the rhetoric of some analysts. Goldman Sachs's Deane Dray, who downgraded GE shares to "neutral" on the news, says the news "raises credibility concerns for GE," and he adds that he expects the "magnitude and timing of GE's miss and sharply lower 2008 guidance to shake investor confidence."

Puh-leeze. To paraphrase a GE slogan, recessions bring bad things to light. Expect more financial-services explosions in coming months.

What's interesting is not that GE's financial-services business got nailed, but how its other businesses performed. Immelt says the company's aviation, energy, transportation and oil and gas operations all had double-digit profit growth, "with no signs of slowing."

More than half of the company's sales are made overseas. GE reported that international sales grew 22% in the first quarter and that sales in developing countries rocketed 38%. Sales of its infrastructure equipment are going gangbusters, which bodes well not just for GE, but for the worldwide economy in general.

GE isn't naive when it comes to financial services, which is also telling about the economy. The company also announced on April 11 that it's on track to sell its U.S. private-label credit-card business and its Japan consumer-lending business. The company knows that consumer credit is a drag on its bottom line at best, and a time bomb at worst.

It also said sales of consumer appliances were soft, reflecting dismal consumer-confidence figures.

So based on GE's report, it appears that damage to the economy is still confined mainly to the credit markets and to consumer spending. The canary just has a bad cough.

If GE starts reporting weakening sales for its industrial products because of a spreading credit crisis, or other reasons, then the canary has pneumonia, and we're in much deeper trouble.

Is GE itself a good investment? Well, the stock is cheap, trading at 14 times the now-reduced 2008 earnings forecast and yielding a well-above-average 3.9%. But the company’s struggle to slim down operations and beef up profits hasn't done much for the share price (earnings rose from $15.1 billion in 2002 to $22.5 billion in 2007, according to Value Line).

At its current level, the stock is only about four bucks higher than it was five years ago. It had climbed to $42 last October, persuading some analysts that the company was on the right path.

If the economy was stronger and GE didn't have one foot in financial services, those analysts might have been right. But those are big ifs, even for a powerful multi-national conglomerate, to shake off anytime soon.