We can all agree that the last few months have been gutwrenching, even for patient and long-term investors. Even value-focused contrarians like me have been whipsawed by violent market reactions to seemingly every headline, rumor, blatant speculation, and musing or rants from our Twitter happy President.

But while the last few months of market declines (for some companies of 20%, 30% or more) has been rough, there are two big reasons why I am very confident that the Trade War that has sent stocks into a tailspin, will be over by February if not sooner. That means the bull market isn’t just likely to survive this correction, but likely continue for at least the next year.

President Trump Is Listening to the Market

President Trump has indicated he cares about just two things when it comes to Trade. First, he wants the cut the trade deficit between the US and China (which he incorrectly sees as a sign that we’re “losing”). Second, he wants revised US trade policies which will help the economy (and his 2020 re-election chances). For good or ill Trump’s key economic barometer appears to be the stock market. Trump spent most of 2017 tweeting about the market’s tax-cut fueled rally. What’s more, during his 2018 State of The Union he even took a victory lap over the market’s performance since his election before Congress, the Supreme Court and tens of millions of Americans watching on TV.

Well, he’s since fallen silent on the stock market, and trade war he’s single handily embarked upon (against the advice of most economists, business leaders, and advisors) has utterly failed to close the US/China trade gap.

In fact, the trade deficit with China has exploded since the trade war began and is now at an all-time high. From Trump’s perspective, this shows that trade wars are not in fact, “good and easy to win”. That’s because the Chinese Yuan has fallen by about 10% due to China’s slowing economy (made worse by the trade war). That has nearly entirely neutralized the current tariffs (effective rate of 12.5% on 50% of Chinese imports). And with the US economy being the strongest of any developed economy right now (thanks to fiscal stimulus including tax cuts) US demand for Chinese imports (which effectively cost the same) have increased. Meanwhile, retaliatory tariffs against US exports to China, including agricultural products grown mostly in deep red states, have fallen dramatically.

And of course, we all know how the stock market feels about the trade war.

Not just have we had two corrections this year, but we’ve also seen five 3+% daily declines in the S&P 500. For context, since 1957 there have been just 98 such days in market history, one occurring, on average, every 1.5 years. They tend to cluster around bear markets and recessions, such as 2008 and 2001. 5% of these days have now occurred in 2018 when the US economy is expected to grow 3.1%, its strongest expansion since 2005.

And while it’s true that worries over the Fed hiking us into a recession are partly to blame for this correction, a few weeks ago Fed Chairman Powell reversed his early hawkish statements about the US being “nowhere close to neutral rates” and is now indicating far fewer hikes are coming. The latest Fed minutes showed a growing dovish consensus among the FOMC as well, which is why that week the S&P 500 had its strongest weekly rally in seven years. It was purely trade-related worries that caused the market to then given back 100% of those gains the following week. That included a 3.2% decline on Tuesday, December 4th (Trump’s infamous “Tariff Man” tweet) and a follow up 3% intraday decline on Thursday (the market was closed on Wednesday for the National Day of Morning). That 6% market slide caused $2 trillion in market cap to evaporate and was only halted by a 3% rally kicked off by a Wall Street Journal article confirming the Fed was looking to take a “one and done” approach (hike in December then pause).

Which brings me to the first big reason why I’m very confident the trade war will soon be over.

The Wall Street Journal reported on December 7th that an administration insider has been told that Trump is “glued” to the stock market each day and worried that the constant stream of contradictory statements (wild swings from claims of trade peace to threats of scorched earth trade war) might be causing the volatility we’re seeing now.

I don’t care if Trump’s use of the market to judge the economy is wrong (short-term market prices are often irrational and based on bi-polar likes swings in fickle sentiment). At least he is listening to something other than his gut, which he’s said often guides his decisions rather than advice from ivory tower academics and Wall Street “professionals”. I think it’s very possible that there would have been no trade truce deal struck at the G20 had the market not been in a correction, giving Trump reason to doubt his confidence in his trade warfighting prowess.

Ok, so maybe Trump appears to only listen to the stock market, but what evidence do I have that the trade negotiations will be successful by the looming March 1st deadline when tariffs go from 10% to 25% on that $200 billion round of imports? That would be from an increasing stream of news that seems to indicate that Trump’s new found desire to make a deal before he breaks the stock market, is causing good progress to be made.

Trade Negotiations Are Going Very Well

• December 3rd: “President Xi and I want this deal to happen, and it probably will” – President Trump
• December 7th: Trade talks are “extremely promising”- National Economic Advisor Larry Kudlow
• December 7th: “China talks are going very well!” – President Trump
• December 12th: “important announcement”, due to “productive conversations” – President Trump

Ok, so maybe there’s some talk from key officials, including the trade warrior in chief himself. But we all know how contradictory the White House can be on trade issues, sometimes even in the same statement. What specifics are there that indicate that progress is being made to end this trade war, eliminate these tariffs, and FINALLY allow this correction to end?

During the G20 dinner meeting, we heard some vague claims (some of which were later contradicted by China) about China’s willingness to make trade concessions. These included importing a large amount of US goods (up to $1.2 trillion over several years), reducing tariffs on US cars, and cracking down on intellectual property theft (a core issue for the US and rightly so).

Well, now we’re finally getting some concrete news about steps China is taking. Specifically, the “important announcement” is that, according to Bloomberg, China is now planning to reduce tariffs on US autos from 40% to 25%. The proposal, which reverses one of China’s retaliatory tariffs imposed in July, will be submitted to China’s cabinet “in the coming days”. It indicates that the US requested the arrest of Huawei’s CFO (who happens to be the founder’s daughter) hasn’t derailed trade talks.

Freya Beamish, the chief Asia economist at Pantheon Macroeconomic, explains the significance of this news well.

“Last week, events seemed to conspire to throw the truce into disarray, but the underlying incentives of both sides at the moment are to try to maintain that truce. Now we are seeing the possibility that China will come through with reductions of tariffs on U.S. autos and that’s another good, concrete step.”

I’d also like to point out that unlike in past weeks, where Trump would match most statements on good trade progress with table-pounding threats of imposing news tariffs if he didn’t get what he wants, now we’re seeing a more subdued president who seems to be looking to “take the win”. What do I mean by that? Well, specifically that in the past Trump has said he was looking for zero tariffs on cars in particular, and all goods in general. China is proposing a 25% reduction in tariffs but not to zero. Trump isn’t saying this is a good start but he wants more but is taking to Twitter to declare this is a huge step forward.

To me, that sounds like Trump is finally tiring of the never-ending trade war and the market volatility it’s been causing. He now realizes the magnitude of what’s at stake (because US economic growth has been slowing noticeably in recent months) and that further wild swings in sentiment could trigger a bear market. That would mean that something he chose to start, over the strong objections of so many “professionals” could very well kill the longest bull market in history.

Does that mean that Trump is going to go “twitter silent” from now on, and avoid stump speech messages like tweeting about how tariffs can “make America rich again!”? No, but it does mean that I expect to see Trump and most administration officials focusing far more on progress than threats, and highlighting what’s going right with negotiations as opposed to demanding everything on their wishlist.

Because at the end of the day, whether it’s the stock market (Trump’s apparent favorite economic gauge) or the exploding trade deficit objectively proving him wrong, Trump isn’t totally ignoring reality. The man realizes that campaign slogans and promises of great deals to come are no longer enough. He needs to actually deliver wins, otherwise a weaker economy and potential bear market will torpedo his re-election chances.

No matter what you may personally think of Trump, I think we can all agree, that, like all politicians, he values electoral victory and survival above all else. And as Trump now seems to realize, his own political survival beyond 2020 is tied to the survival of the bull market, and the good economy and strong job market that drives it.

Bottom Line: Trump Political Survival Depends on a Trade Deal

Turbulent times like these try all investors’ souls, but that’s why it’s important to keep a cool head, think rationally, and look at not just what important actors (like President Trump) say, but what they actually do. While Trump has been famous for his hawkish trade stances, at the end of the day his stated goals of cutting trade deals have lined up with what he’s ultimately done (with other countries). And with the President’s G20 deal seemingly confirming CNBC’s claims that he’s “glued to the market” during this correction, I am confident that the trade negotiations that are going very well by all accounts, will ultimately result in the trade war ending by February if not sooner.

That doesn’t mean that the economic or earnings damage that has already been done will be reversed entirely or quickly. However, it should be enough to avoid this correction turning into a full-blown bear market. While next year isn’t likely to be a repeat of 2017’s freakishly low volatility year-long rally, I expect the bull market still has at least 12 months left before it finally runs out of gas.

Cannabis stocks like Tilray have become the cryptocurrencies of 2018. Specifically, ever larger number of states legalizing both medical (30 + DC) and recreational (9 US states) cannabis, plus Canada legalizing its recreational use, have sent speculators into a frenzy.

This is why cannabis stock Tilray hit a market cap of $20 billion at one point, at which time it was valued at an absolutely crazy 1,300 times sales. But just why are investors so bullish on cannabis stocks? Because of facts like these:

• The population of the US states that have legalized medical cannabis is 200 million
• In early 2018 an estimated 2.7 million Americans used medical cannabis
• In 2017 the industry grew 32% to $7.9 billion in sales
• By 2022 forecasts call for medical cannabis alone (excluding recreational use) to hit $29 billion, representing a 26% annualized growth rate over the next four years
• Professional services firm Deloitte estimates that Canada’s recreational market by 2019 will be worth $5.3 billion in sales
• According to analyst firm, Cowen & Company by 2030 Global Cannabis sales might hit $75 billion, surpassing soda (in Aurora, CO cannabis already outsells alcohol, so this might not be so crazy)

The bottom line is that today cannabis is starting out a tiny legal industry (and only in some places) and likely to become legal in far more jurisdictions, fueling massive growth. There’s literally a fortune to be made by smart investors who know which stocks to buy to cash in on this industry that’s growing like a weed. Which stocks are those? Well, you might be surprised to learn that the best (and lowest risk) way to profit from the cannabis boom isn’t one of the well-known (and massively overpriced) growers but rather one of the fastest growing dividend stocks in America.

Let’s take a look at why Innovative Industrial Properties (IIPR) is hands down the best way to profit from cannabis, all while enjoying (relatively) safe dividends growing at spectacular rates.

Forget The Growers! You Want To Own The Landlord

Innovative Industrial Properties is technically an industrial REIT, but in reality, it’s a niche triple net lease specialty REIT. It was founded in 2016 as the only REIT to rent commercial grow space to licensed medical cannabis growers in the US. Today the REIT owns 10 ten properties located in:

• Arizona
• Colorado
• Maryland
• Massachusetts
• Michigan
• Minnesota
• New York
• Pennsylvania

These 10 properties total approximately 952,000 rentable square feet (including approximately 114,000 rentable square feet under development). They are leased under very long-term leases (average remaining lease 14.7 years) under what’s called “triple net leases”. The way it works is that IIPR will buy a grow facility from a cannabis company and then lease it back to them at rents that create a cash yield on investment (based on sale price) of about 15% (average across its property base is actually 15.7%). The tenant not just pays the rent, but also the maintenance cost, property taxes, and insurance. IIPR is literally just the landlord and its leases have 3% to 4% annual rental escalators built in meaning that tenant rent rises about 3.5% per year, or nearly double the rate of inflation.

To give you an idea of just how profitable these leases are, consider this. Triple net leases are most popular in retail REITs, where cash yields range from 5% to 8%. Annual escalators usually run 1% to 2%. The average triple net lease is able to buy a property for an investment spread (cash yield minus cost of capital) of 1% to 3%. That’s good enough to grow adjusted funds from operation or AFFO/share over time. AFFO is the REIT equivalent of free cash flow and what funds the dividend.

IIPR has a cost of capital of just 3.1% and is targeting 15% cash yields on new properties. That means about 12% investment spreads or roughly six times the industry average. And its rent rises at double the industry average, meaning that the REIT will become more profitable over time. In fact, YTD AFFO margin (AFFO/revenue) is already 60% which is close to the industry average. And that’s despite this REIT being extremely small (10 properties, $12 million TTM revenue and $435 million market cap). As it gets bigger its administrative costs (like paying executives and running the head office) will get spread out over exponentially more revenue and its AFFO margin will soar. Within a few years, if it continues to acquire properties quickly (three in the past four months) IIPR could easily become the most profitable REIT in America.

That high and rising profitability, combined with growing off a small base, means that Innovative Industrial is growing at rates that would put most tech stocks to shame. For example in Q3 2018 revenue rose 150% and here are the REIT’s YTD 2018 results:

• Revenue growth: 142%
• AFFO: 297% (rising profitability from growing economies of scale)
• Share count growth: 94% (funding 100% of growth with equity)
• AFFO/share growth (REIT bottom line): 111%
• Dividend Growth: 183%
• AFFO Payout Ratio: 91% (dividend sustainable and covered by cash flow)

Such growth is fueling amazing total returns for investors.

(Source: Ycharts)

Better yet? Analysts currently expect IIPR to grow its AFFO/share by about 100% in 2018, 100% in 2019 and a still very fast 40% in 2020. In fact, analysts are forecasting 40% annualized AFFO/share growth (which is what the share price is ultimately based on) for the next 10 years.

(Source: Fast Graphs)

The dividend is expected to grow slightly slower, to let the REIT lower its AFFO payout ratio and thus retain more cash to reinvest in the business. That’s a very good thing because a unique feature about IIPR’s funding strategy is that it has no debt and plans to issue no debt in the future. That’s because no institutional investors will buy bonds in any way connected to a business that is, at least at the Federal level, 100% illegal. (See risk section).

However, over time IIPR should be able to lower its payout ratio to about 50%. That’s typically the lowest a REIT can go because to maintain REIT status (and pay no corporate taxes) all REITs must pay out 90% of taxable income as dividends. Taxable income for a REIT is NOT the same as GAAP EPS or AFFO. Typically the minimum payout ratio required to maintain REIT status is about 50%. If IIPR gets to that payout ratio then not just will the dividend be one of the safest in all of REITdom, but it will be retaining 33% of its cash flow and thus able to lower its equity issuances. Since every new share sold is dilutive (and raises the dividend cost) achieving this level of internal funding will allow IIPR to maintain its hyper-growth rate even longer.

Ok, so IIPR is a very fast growing REIT, whose dividend (and share price) are soaring to the heavens on the back of the secular tailwinds created by this fast-growing industry. But just how much can investors make on this REIT? Well, that depends on whether you believe analysts hyper bullish growth assumptions (I personally think they are overly optimistic). But realistically I think investors might be able to multiply their money 10 fold over the next decade.

Dividend Hypergrowth Potentially Means Some Of The Best Stock Returns Of The Coming Decade AND The Stock Is Also Reasonably Priced

Total returns are made up of three parts: yield, share price appreciation (a function of cash flow and dividend growth) and valuation changes. I’ll address valuation in a second but assuming a dividend stock starts out at fair value then total returns will generally follow the formula yield + dividend growth.

• Yield: 3.1%
• 2018 AFFO payout ratio: 88%
• Debt/Adjusted EBITDA: 0 (no debt)
• Analyst Consensus 10 Year AFFO/share Growth Rate: 40%
• Realistic 10 Year Cash Flow Growth Rate: 20%
• My Expected 10 Year CAGR Dividend Growth Rate: 15% to 20%
• Potential CAGR Total Return: 43.1% (Based On Analyst Consensus)
• Realistic Long-Term CAGR Total Return: 18.1% to 23.1%
• S&P 500’s Historical CAGR Total Return: 9.2%
• Expected 5 to 10 Year CAGR S&P 500 Total Return (Morningstar, BlackRock, Vanguard): 0% to 5%

As far as REITs go IIPR’s 3.1% yield isn’t especially high. But as far as dividend stocks go it’s pretty nice, especially given that the dividend is expected to grow 140% by the end of 2020. And given that the payout ratio is already below 100% (sustainable) and expected to fall to 74% by the end of 2020, the dividend appears low-risk (as far as coverage ratio goes). Dividend safety is also enhanced by a pristine balance sheet with no debt (though not because management has a choice).

What will ultimately make IIPR a great investment is the cash flow growth rate since REITs tend to be priced as a function of AFFO. If analysts are right about the REIT being able to maintain 40% growth rates through 2028, then hands down IIPR becomes the best stock you can own for the next decade, period. Personally, I think that, given the size of the addressable market, and its incredibly scalable business model (gets more profitable over time as the REIT achieves economies of scale) 20% CAGR growth over 10 years is reasonable. That translates into 15% to 20% dividend growth over time and total returns of 18.1% to 23.1%. If IIPR surprises me even a bit to the upside then the stock could increase your investment (including dividends and dividend reinvestment) by 10 fold in the next 10 years. That’s far better return potential than you’re likely to get from other cannabis stocks. Not just because their valuations are currently stretched but also because cannabis growers are selling a commodity product and thus are likely to become less profitable over time (margin compression).

Meanwhile, IIPR is trading at 32.4 times analyst estimates of 2018 AFFO and 16.3 times 2019 estimates (forward P/AFFO ratio). The P/AFFO ratio is the REIT equivalent of a PE ratio.

• Price/2018 AFFO: 32.4
• Price/2019 AFFO: 16.3 (REIT average P/AFFO 16.1)
• Growth Rate Baked Into Current Price: 12%
• Expected Growth Rate: 20% to 40%
• Fair Value P/AFFO: 44.1 to 80.5
• Discount To Fair Value: 27% to 60%

Even the 2018 estimate is only baking in 12% long-term growth which is far below what the REIT should be able to achieve (assuming nothing in the risk section happens). Based on a formula developed by Benjamin Graham, Buffett’s mentor and the father of modern value investing, a reasonable P/AFFO for a REIT growing at 20% over the long-term is 44.1. That implies IIPR is about 27% undervalued, and if analysts are right then the stock might be as much as 60% undervalued.

Either way, I can certainly recommend this fast growing REIT to anyone who is comfortable with its rather unique risk profile.

Risks To Consider

There are four main risks to IIPR’s extremely bullish growth thesis. The first stems from the fact that cannabis remains illegal at the Federal level (schedule 1 narcotic, the same classification as Heroine). This has important implications for both this REIT and all US cannabis companies.

Specifically, that, should the Feds ever decide to crack down on cannabis in states where it’s legal (as is technically DC’s right) then many cannabis companies, including IIPR’s tenants, might go bankrupt. Due to being illegal Federally, today cannabis companies are not able to access traditional financial markets or services. Most banks won’t even allow a cannabis business to have a checking account because they fear running afoul of drug money laundering laws.

This is likely why Innovative Industrial has no debt, because, simply put, no bank or financial institution will lend to them. As a result, the REIT is forced to fund 100% of its growth with retained cash flow or new equity. Now that’s fine, as long as the share price remains high and climbing (keeping the cost of equity low). As long as IIPR’s AFFO yield is lower than the sky-high cash yields on new properties it buys (15%) then it will be able to grow AFFO/share and its dividends.

And eventually, the REIT is expected to lower its payout ratio enough that it might be able to retain up to 33% of cash flow and buy its properties without issuing new shares (which dilutes investors and slows AFFO/share growth). However, that point is likely far off (four to five years). Until then IIPR’s hypergrowth story remains 100% dependent on remaining a Wall Street darling.

So far that hasn’t been a problem, with the stock easily crushing not just most REITs since its IPO but also blowing the S&P 500 out of the water. Just be aware that in the event of a market downturn, such as a recession-induced bear market, general market panic might cause the share price to fall, and thus cut off the REIT from its primary source of growth funding.

And it might not just be general market pessimism that threatens the stock price. Any negative cannabis news or even sentiment (say a popping of the cannabis stock bubble) might also send shares tanking. As would any negative IIPR news, such as one of its tenants defaulting on its rent. Remember that the REIT only has 10 properties so far, which means each one represents a significant percentage of its revenue. If one or two ends up getting into financial trouble, then IIPR’s hyper-growth might rapidly slow down or it might even report negative AFFO/share growth. While the current payout ratio is sustainable and expected to improve over time (down to 74% by the end of 2020), any tenant trouble might either force the REIT to slow its dividend growth (bad for the share price) or even potentially cut it (terrible for the share price).

Basically, this means that for the next few years, until the REIT can diversify its tenant base and become more self-sufficient in its growth funding, IIPR will remain a high-risk stock. Thus, even if you are comfortable with its risk profile, you should limit your position size so as to be able to sleep at night in case of a worst case scenario. Personally, I cap high-risk stocks at 2.5% of my portfolio (though in reality, my 2 high-risk stocks are about half that).

Bottom Line: Cannabis Is Highly Speculative, But Innovative Industrial Properties Is The Lowest Risk Way To Profit From An Industry That’s Growing Like A Weed

Let me be very clear that as long as cannabis is illegal at the federal level all cannabis stocks will be high risk. That includes Innovative Industrial Properties. However, fundamentally IIPR’s business model, built on long-term (and super profitable) leases with very high annual rental escalators, is hands down the least risky way to cash on in the huge growth potential in this young, speculative but fast-growing market.

As long as the current hands-off Federal government approach to legalized cannabis remains in effect, and its stock price high, this will likely be the fastest growing fastest growing companies in America. That means that investors in this small cap, niche REIT might enjoy sensational dividend growth and mouth-watering capital gains. If analysts growth expectations prove even 50% correct than IIPR could realistically increase your investment about 10 fold over the coming decade making it a great high-risk/high reward investment opportunity. In fact, I plan to buy IIPR during the next market downturn, because I believe its dividend growth and total return potential is worthy of a 2.5% stake in my portfolio.

Most investors know the famous Buffett saying that the best way to get rich is to “be greedy when others are fearful”. That means that deep value investing, buying stocks that the Wall Street absolutely hates, can be a great way to generate market-crushing returns over time.

(Source: Ycharts)

Well, right now few stocks are more hated than GE, which has seen shares plunge 76% in the past 18 months from its mid-2016 highs. The company now trades at levels not seen since the darkest days of the Financial crisis.

Given GE’s storied 126 year history, some deep value investors might be tempted to buy this stock purely as a “cigar butt” investment. However, I strongly caution against that, because while GE is certainly cheap now, I fear it might fall much lower. In fact, there are three reasons why I won’t touch GE…at any price and recommend you do the same.

To quote the Oracle of Omaha once more “it’s better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

In today’s market there are plenty of great quality companies trading at not just fair prices, but firesale valuations. Meanwhile, GE isn’t close to being a “fair” company but is a toxic collection of shrinking assets and a mountain of liabilities that might potentially decline much lower.  

Dividend Cutters Are The Worst Performing Asset Class You Can Own

Since 1900 stocks have been the best performing asset class, and among stocks dividend growth stocks (and companies that start paying rising dividends) have been the best performers by far.

The absolute worst class of investment (including bonds and cash) has been stocks that have cut their dividends. GE hasn’t just cut its payout once, but three times now in the past 11 years, by a stunning 97% since its 2007 high.

But who cares about the dividend? GE is a pure deep value play, right? And under the leadership of new CEO Larry Culp, who led rival industrial conglomerate rival Danaher to 400% returns over his tenure, GE is going to right the ship and soar much higher in a few years, right? Well as Buffett once said:

“When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”

And the sad fact is that GE’s business quality remains poor (and rapidly deteriorating) and its troubles are likely far from over.

GE’s Troubles Are Far From Over

Deep value investing, which I’m a big fan of, is based on a core idea that “it’s always darkest before the dawn”. However, there’s another famous saying that value investors need to remember “it’s always darkest before things go totally black”.

Good value investing is about finding quality businesses with good assets, run by skilled management teams that are experiencing short-term troubles that are eventually surmountable. GE’s troubles are legion and include continued toxic asset liabilities from the days when GE Capital took part in the sub-prime mortgage debacle. That’s why in January it was forced to declare a $6.2 billion tax charge pertaining to the insurance business it no longer owns.

Worse still the company has $115 billion in total liabilities including a $30 billion underfunded pension that is the largest in Corporate America. This has forced management to undertake drastic and desperate moves to shore up the balance sheet. That includes selling off numerous assets including 20% of GE Healthcare and spinning off that division, one of the two crown jewels it owns, in 2019. That’s so that GE can unload $18 billion in debt and pension liabilities onto GE healthcare and thus slightly improve its financial standing. Back In June GE said it wanted to cut its debt by $25 billion by 2020 and was looking at potentially $60 billion in possible asset sales.  

New management just pulled the trigger on one of those with the desperate deal it struck with Baker Hughes, a GE Company. Back in mid-2017, when GE bought Baker, it agreed to not sell any shares for two years. The two companies have just changed that agreement so that GE can sell 25% of its stake in the company (partially back to Baker) to raise $4 billion in a hurry.

BAKER HUGHES, A GE COMPANY STOCK PERFORMANCE, DATA BY YCHARTS.

The trouble is that GE’s timing on this move couldn’t be worse. Oil prices have recently crashed into a bear market, down as much as 26% off their recent October highs. As a result, Baker Hughes’ price has cratered and yet GE still felt the need to immediately cash out a large chunk of its position in the company. That indicates that the company’s other fundamentals might be in bigger trouble than we know.

In fact, those deteriorating fundamentals are precisely why JPMorgan thinks that GE isn’t done falling, by a long shot. According to JPMorgan’s analysis (which I agree with) GE might end up plunging another 28%, to $6. That would be lower than in 2009 when GE bottomed at $6.66 after being bailed out by both Buffett and the Federal Government (without which it would have been bankrupt).  

The Company’s Stock Could Fall MUCH Further

GE has been dismantling itself for years now, but under its last revealed turnaround plan said it would end up owning just three core businesses: aviation, power and renewable energy. The reason for holding onto just those three businesses is that they all use turbines, which GE believes it can leverage its R&D across all three business units to maximize long-term profitability.

However, in wind turbines (which makes up 89% of the company’s renewable energy sales, GE is now facing rising cost pressure from big rivals. In fact, since GE is 4th in wind turbine market share it actually lacks the economies of scale to maintain strong profitability in that unit. But wait it gets worse.

GE Power, the energy generation division, just announced a $22 billion write-down, which is so large that both the SEC and Justice Department are now investing the company for potential accounting irregularities. In Q3 Power reported a $630 million loss, and its the continued declines in both revenue and cash flow from that division that is the reason that YTD free cash flow for the company is -$335 million. Note that as recently as 6 months ago management was guiding for free cash flow of $6 to $7 billion. Last quarter that was revised down to $6 billion and now management is saying it’s going to miss that by a wide margin (but is not offering any actual figure).

Free cash flow is what’s left over after running the company and investing in future growth. It’s what funds dividends, buybacks and repays debt. GE’s FCF has fallen off a cliff and JPMorgan analyst Stephen Tusa estimates that by 2020 six of the company’s remaining eight business units will be generating zero (or negative) free cash flow.

Even with GE unloading so many assets (some at fire-sale prices) to pay down its debt, its FCF is falling even faster and could soon turn negative. That could create the terrible scenario in which the company’s leverage ratio (debt/EBITDA) actually increases and it continues to get more credit rating downgrades. S&P has already downgraded GE’s credit rating from A- to BBB+ and Moody’s has put its rating under review for a possible downgrade. But while GE’s credit is still three notches above junk according to the rating agencies the bond market disagrees. Recently GE’s bond prices have collapsed (right after the desperate Baker Hughes deal was announced) sending their yields firmly into junk bond territory.

Basically, the bond market is fast losing confidence in GE’s turnaround story. Mutual fund managers feel the same with Bloomberg reporting on Nov 12th that fund managers were dumping larger and larger blocks of stock “as fast as possible”. With so many rats fleeing this sinking ship investor might want to avoid buying the ship, even for a token amount.

That’s because of the company’s tangible book value per share (its net liquidation value in case of bankruptcy) which peaked at $6 in early 2015 but has since slid a remarkable $11.5 per share.

(Source: Ycharts)

That means that GE’s intrinsic value might be far below the $6 that JPMorgan is warning it might fall too. In fact, GE’s rapidly shrinking, and deteriorating businesses might be worth nothing at all. That’s not to say that I think GE will go bankrupt, but I certainly think it’s looking more and more likely that GE is going to have to keep selling or spinning off units until potentially the future GE is left with nothing but its Aviation unit, the one thriving part of the business.

In the meantime, deep value investors are going to be left with effectively no dividend to speak of and possibly several more quarters (or even years) of falling share prices. With so many great deep value opportunities out there (here are 11 stocks I’ve been buying during this correction) I can’t think of any reason for investors to take a flyer on this foundering and still flailing industrial giant.

Bottom Line: Deep Value Investing Can Be A Great Strategy But There Are FAR Better Choices Out There Than GE

There is a big difference between a deep value opportunity and a value trap. Good deep value stocks are those with strong core assets, solid management teams, and otherwise good and growing businesses. Their fundamentals are strong, meaning that revenue, cash flow, and dividends are all moving higher. For such companies you can buy with confidence knowing that at some point the market won’ be able to ignore strong and rising fundamentals forever and thus the valuation multiple will soar, earning you strong capital gains. This is the core strategy of my high-yield income growth retirement portfolio. On the other hand value traps are companies with:

• Weak balance sheets
• Deteriorating fundamentals (sales, earnings, cash flow)
• Falling dividends
• No clear long-term growth runway

Such stocks can see their share prices not just languish in the toilet forever, but can even fall to zero. No blue chip, no matter how storied, is immune from the creative destruction of capitalism. Sears was once the world’s largest retailer (the Amazon of its day) and is now bankrupt and likely headed for liquidation. While GE will probably survive in some form, I can’t personally bet my hard earned money on when or where this low-quality stock will bottom and recommend you avoid taking this high-risk gamble yourself.

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