Once bitten, twice shy — that’s the attitude that investors tend to take with companies that slash or eliminate dividends, and with good reason.
If you are buying a stock with the intention of using the dividend to pay your living expenses, a dividend cut can take a wrecking ball to your retirement plans.
That’s why income investors fell out of love with iconic American blue chip General Electric (GE). During the pits of the financial crisis, when the venerable old company had to go begging to Warren Buffett for cash, GE stock cut its quarterly dividend from 31 cents to just 10 cents in early 2009.
Now, I certainly understand why GE did it. When you’re in bad enough financial shape to justify paying Mr. Buffett a 10% perpetual preferred-stock dividend, it makes prudent business sense to cut the common dividend. But income investors have long memories, and many are going to find it hard to trust General Electric with their retirement again.
But now that more than six years have passed since GE took a machete to its payout, I can say that it’s finally safe to trust GE stock’s dividend again.
Let’s dig into the details.
GE Stock Dividends Back on Track
At a current dividend yield of 3.7%, GE is one of the highest-yielding stocks in America outside of “traditional” income sectors like utilities, telecom, or tobacco.
The General Electric dividend, at 23 cents per share, is still well below its old precrisis high of 31 cents. But to GE stock’s credit, the company has raised its dividend by 130% since 2009. So GE has clearly made it a priority to reward its long-suffering shareholders with solid dividend hikes.
Over the past five years, GE has raised its dividend at an 17% compounded annual clip. And there is every reason to believe the dividend is safe for the foreseeable future. General Electric’s dividend payout ratio, at just 45%, is near the bottom end of its range of the past five years.
But the real reason to have a little faith in GE’s dividend is that this is a very different company than the one that slashed it back in 2009.
Pre-crisis, GE had essentially morphed into an enormous Wall Street bank that also happened to run an industrial business on the side. In fact, the U.S. regulators deemed it a “systemically important financial institution” due to the size and scope of GE Capital’s operations.
As recently as two years ago, GE Capital, as a standalone institution, would have been the seventh-largest bank in America.
All of that changed earlier this year.
Cleaning Financial House
Back in April, GE made the decision to essentially dump GE Capital as a way of getting out from under the regulator’s thumb and finally putting the legacy of the 2008 meltdown behind it.
This is a big deal, as GE Capital has long been the biggest driver of GE’s profit … as well as its biggest source of risk. It was GE Capital’s shoddy investments during the housing boom and bust that nearly buried the company.
Yet, getting rid of it has been hard. GE Capital accounted for 30 percent of GE’s annual revenue over the past four years but fully 51 percent of its after-tax income.
GE has been trying to shrink GE Capital for years and replace the lost revenues with growth in its industrial business lines, but the reorganization hasn’t been particularly easy. Corporate-wide revenues are still down by nearly 20% from their precrisis highs, and gross margins are down about 40%.
But as it has become a slimmer company, GE has also managed to trim back its risk profile. Its long-term debt outstanding has shrunk from $316 million in 2011 to just $248 million today.
All in all, the post-GE-Capital General Electric will be a far less risky, albeit less profitable, industrial conglomerate.
It’s not all wine and roses for GE stock going forward, and there will always be risks with which to contend. For instance , earlier this year, GE had to slash spending and headcount in its energy unit as the plummeting price of crude oil has reduced the need for new equipment.
But overall, with GE Capital on the way out, GE stock is now pretty well shorn of the sort of “black swan” risk that could bury the company. That might make it a little less interesting as a growth story.
But it makes it a lot more attractive as a safe dividend stock.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. As of this writing, he did not hold a position in any of the aforementioned securities.