Returns and management
With the news that Jeff Immelt is stepping down as chief executive officer of General Electric Co, it seems worthwhile to take an early measure of his legacy. After 16 years at the helm, with the stock price essentially unchanged since he took over, the announcement wasn’t all that much of a surprise. Still, the standard appraisal of his tenure is subject to many of the classic errors that afflict so many investors.
As CEO, Immelt followed the legendary Jack Welch. Depending upon the version you prefer, Welch was either a management genius, very lucky, or a cheater who cooked the books. Since Immelt is so often compared to his predecessor, let’s consider the foundation on which the Welch edifice is built:
Lucky timing: Welch took over as CEO in late 1981. This was as a 16-year bear market was coming to an end, and on the eve of an historic 18-year bull market. We cannot underestimate how significant that good fortune was in the Welch-is-a-genius narrative. Investors consistently confuse correlation with causation. The good timing doesn’t mean that Welch wasn’t a fine or even a great CEO; the question it raises is whether investors can understand how much of GE’s stock-market success is attributable to his management skills or to the overall rise in the stock market, especially among large capitalisation stocks.
Consider that during that bull market, GE’s revenue grew 385 per cent, but the company’s market value rose 4,000 per cent. How did that happen? GE increased earnings during those years and, with stunning regularity, managed to exceed quarterly profit estimates.
Immelt came on in the early months of a 13-year bear market (2000-2013). He managed the company through the financial crisis, and that was after taking over just before the company’s accounting scandal came to light.
Fraud: which brings us to the regularity of GE’s earnings — they were a little too regular: after the 2000 stock-market bust, we learnt of earnings manipulation and accounting shenanigans. The criticism was that GE Capital acted as an opaque leveraged hedge fund that always could be counted on to help GE beat profit forecasts by a penny. GE eventually settled accounting fraud charges with the Securities and Exchange Commission and paid a $50 million penalty.
Although the accounting manipulation came to light during Immelt’s tenure, they likely predated his term. Barron’s for example, reported that the company underfunded reinsurance reserves by $9.4 billion, helping to inflate profits from 1997 to 2001. Immelt was in charge of cleaning up the mess left by Welch.
Halo effect: by the time he retired in 2000, Welch had become a superstar. To this day there are GE shareholders who refuse to accept he did anything wrong.
A classic example of the halo effect is contained in Jim Collin’s 2001 book Good to Great. Eleven “fantastic” companies selected for their market performance were cited as examples of management brilliance. Most subsequently crashed and burnt. The author ignored the halo effect, confusing good stock returns during a huge bull market for management genius.
One other advantage Welch had: At the time, GE owned NBC, including the financial and business news channel CNBC. Welch skilfully managed his image via the channel, invariably getting good press. The anchors even joked about softball questions while interviewing the boss. It not only set the tone for the rest of the press, but it helped drive the legacy of Welch, making him almost bulletproof in the investing public’s imagination. The accounting scandal and unimpressive stock performance made it almost impossible for Immelt to appear on CNBC and crow in the same way that Welch did. GE sold NBC to Comcast Corp for about $30 billion in 2009. Stealing from the future: Recoveries from stock-market bubbles take a long time. Enormous gains, especially in the final innings of the frenzy, are outsized relative to median performance. I have described this as stealing returns from the future, and it inevitably leads to subsequent mean reversion and years of stock underperformance.
Does anyone doubt that big market gains, partly based on fraudulent accounting and fake earnings, are a fatal combination to future market returns? That was the hand dealt to Immelt by his predecessor and the financial markets.
There isn’t a whole lot of glory to be found reassuring shareholders that the false earnings reports are no longer happening and that the company’s sullied books are now clean. That is a long, slow and distracting process.
Welch had lucky timing, Immelt didn’t. The accounting shenanigans at GE Capital under Welch, followed by the financial credit crisis, all but guaranteed that Immelt would come up short. Despite this, many still consider Welch the gold standard for CEOs.
I am not suggesting that Welch was an awful CEO or that Immelt was great. Rather, in reconsidering the two CEOS in light of all the facts, it seems clear that one was given more credit than is due while the other got less.
Barry Ritholtz is a Bloomberg View columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He blogs at the Big Picture and is the author of Bailout Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy
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