Why General Electric Company’s Dividend Cut Is a Buying Opportunity

GE stock - Why General Electric Company’s Dividend Cut Is a Buying Opportunity

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General Electric Company (NYSE:GE) has instituted its second dividend cut since the Great Depression. This GE news sent the stock down by over 7% when it was announced, and GE stock may see further decline.

However, the company has now taken the action it needs, namely placing itself in a stronger position on cash flow. Now that the company is acting to bring dividends in line with cash flows, address waste, and shed declining businesses, GE stock could be poised for its next renaissance.

GE Needed the Dividend Cut

In my recent analysis of GE, I stated that GE needed a reduced dividend to help bring its fiscal house in order. GE has now taken that psychologically difficult step.

It’s that very psychology that will drive selling in the near term since the company no longer maintains this veneer of financial strength. However, often an admission of weakness serves as a first step in returning to financial strength.

The dividend had been costing the company $8 billion. Since the company halved the dividend, that cost falls to $4 billion. According to JPMorgan, the dividend will claim about 85% of GE’s free cash flow.

Despite the dividend cut, older industrial companies such as Boeing Co (NYSE:BA), United Technologies Corporation (NYSE:UTX) and Honeywell International Inc. (NYSE:HON) will still pay a lower percentage of cash flow into dividends.

However, if history serves as an indicator, buyers will reward GE stock for the stronger cash position in the end. The company last cut its dividend in 2009. Within two weeks of the previous cut, the stock had recovered to its pre-dividend-cut price. Within two months, the stock rose an additional 25%.

Timelines and percentages could differ this time. However, history could repeat itself, with stockholders again seeing an initial drop followed by a large increase in the GE stock price.

Dividends Are Not the Only Thing Being Cut

The lingering question is where does the company go from there? GE had the world’s largest market cap in 2001 when CEO John F. Welch, Jr. left his position. The stock fell steadily for 16 years under the leadership of Jeffrey Immelt. Over the course of Mr. Immelt’s tenure, the market cap lost close to half its value. Today, GE no longer ranks in the top 25 regarding market cap.

Whether current CEO John L. Flannery can bring GE back to the top remains to be seen. So far, Mr. Flannery has announced a $2-billion cost-reduction initiative. He also plans to sell $20 billion in underperforming businesses.

The cuts include a 25% reduction in headcount, which started earlier this year and is nearly complete. Also going away is its transportation business and the iconic light bulb business.

Both have been part of GE since the beginning, with the light bulb serving as the symbol of GE for many decades. By the time Mr. Flannery completes the restructuring, GE will be a smaller but likely more nimble company.

GE Continues to Evolve

The cost reductions and restructuring will facilitate a continuation of GE’s success. Thomas Edison, J.P. Morgan and others founded GE in 1892 as a company built on Thomas Edison’s electric-related inventions. By 1896, it had become one of the original 12 stocks placed in the Dow Jones Industrial Index.

Today, GE stock is the only one of the original 12 to still be listed in the index. (The stock has not been continuously in the index, however.)

Since the 1890s, General Electric has invested and divested itself from related and often unrelated businesses to form one of the largest conglomerates in the world. GE stock has survived several periods of decline. Each time, GE changed technologies, improved its offerings, and recovered. The company will likely follow this pattern again.

Bottom Line on GE Stock

By cutting its dividend, GE has made a move that’s good for GE stock, at least long term. Investors will initially punish GE as dividend cuts indicate financial instability. However, in time, investors will view this dividend cut as an admission of financial problems that already existed.

Once the initial shock abates, GE stock will become a great buying opportunity. By getting in soon, buyers might maximize the returns from what is likely the beginning of GE’s next growth period.

As of this writing, Will Healy did not hold a position in any of the aforementioned stocks.

Article printed from InvestorPlace Media, https://investorplace.com/2017/11/why-general-electric-companys-dividend-cut-is-buying-opportunity/.

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