GE stock: Despite the electrifying drop, hang on

— -- Q: My family and I have bought and owned General Electric stock ge for years. It's been the largest holding in our portfolios because it seems well managed. But with the stock down so much, should we diversify?

A: General Electric is the bluest of the blue chips. And not surprisingly, the stock has found its way into most investors' portfolios.

GE has been the No. 1 stock among the portfolios of USATODAY.com readers for years. You can see what other stocks USATODAY.com readers own in the exclusive USATODAY.com Readers' Choice list, which is also available in the print edition.

But GE hasn't been acting like a blue chip lately. Recently, the company reported sharply lower earnings, down 22%, in its third quarter. Read more about the quarterly report here. The company also agreed to pay Warren Buffett of Berkshire Hathaway a staggering 10% annual dividend on preferred stock he's buying. That a AAA-rated company would be willing to pay 10% interest indicates how badly it needs, or wants, the cash and the difficulty it's having raising it by conventional means.

Investors often make the mistake of thinking that if they own GE they're diversified. GE is massive and has businesses in many sectors, from finance to manufacturing and media. But, owning GE is much riskier than owning a diversified basket of stocks.

So, GE has shown itself to be vulnerable in the current downturn. Its stock has gone from more than $40 a share to less than $20 the past year. What do you do if you own it?

To analyze what to do with GE, we'll put the stock through the four tests Ask Matt puts every stock through:

Step 1: Risk vs. reward. When you take a risk on a stock, you want to make sure you're properly rewarded. Downloading GE's trading history back to 1962, we see the company generated an average annual compound rate of stock appreciation of 7.1%. That doesn't include dividends the company paid. Currently, the stock is yielding 6%, but historically, that yield has been closer to 2.8%, according to GE. If you add 2.8 percentage points to the 7.1% stock appreciation, that gets you to a 9.9% annualized return. That's slightly more than the 9.5% average annual return of the Standard & Poor's 500 during that time, which includes dividends, says IFA.

But here's the interesting point. While GE's returns have been close to the market's, the risk is much higher. Since 1962, GE's stock has missed or topped its average annual return by 25.2 percentage points. That's 71% more volatile than the S&P 500, which generated standard deviation, or risk, of 14.7 percentage points during that time.

You read that right. By owning GE over a long period of time, you got about the same return you would have gotten from owning an S&P 500 stock index mutual fund, but you took 71% more risk. You're getting a taste of how uncomfortable risk is now. And that's just not a good tradeoff.

Step 2: Measure the stock's discounted cash flow. Some investors decide if a stock is pricey by comparing its current price to the present value of its expected cash flows. It's a complicated analysis made simple with a system from NewConstructs. When we run GE's stock, we find it's rated "attractive." In other words, the current stock price is much less than what the company is expected to generate in cash over its lifetime. Using this analysis, it would appear GE stock has fallen so much that it's probably not a great time sell.

Step 3: Compare the stock's current valuation to its historical range. BetterInvesting's Stock Selection Guide can help. If you believe the analysts, which are calling for GE to generate 11% average annual earnings growth the next five years, the stock is in the "buy" range. Another reason to think that GE, despite its problems, shouldn't be on your list of stocks to sell right now.

Step 4: Check the company's financial health. Before investing in any company, you want to make sure it's in good financial shape. A quick way to check is to look at where it falls on the USA TODAY Stock Meter, which ranks stocks from conservative (1) to aggressive (5). GE scores a solid 1.8 here. Plus, remember GE is one of a handful of companies with a AAA-rating from Standard & Poor's. That means it is more able to borrow than most companies. You can get a Stock Meter score for almost any stock by going to money.usatoday.com and putting the stock's ticker symbol or name into the Get a Quote box.

The bottom line. The next time someone tells you they're diversified because they own GE, you know better. While GE is one of the oldest and more diversified U.S. companies, the stock is much riskier than the market in general.

However, if you've owned GE for generations, today is probably not the best time to sell. Acknowledge the fact that you own a stock that is more speculative than the stock market and know that you'll need to ride out some bumps. Eventually, you might get a chance to lighten your exposure to GE — and you should take it.

But more important, learn from this. If you want to get the most return for the risk you're taking, you need to own more than one stock, even if that one stock is GE.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.