General Electric: Becoming Your Daddy's Dividend Stalwart Again

Jun.21.13 | About: General Electric (GE)

Over the past twenty or so years, there have been two conditions that have prevented General Electric (NYSE:GE) from performing in line with the expectations that the company had gradually built up over the course of the twentieth century.

First, and this one was largely out of the company's control, shareholders chose to pay an obscene valuation for shares of GE at the turn of the millennium. From 1998 to 2001, GE had an average P/E multiple above 30, peaking at an average P/E multiple of 41 in the year 2000. Nowadays, each share of General Electric is producing $1.70 in earnings. Considering that the price of the stock is $23.25, that means we're looking at a P/E ratio of less than 14. And if you use trailing twelve month earnings, you are looking at a P/E ratio of 16.25. Either way you look at it, General Electric's valuation is much cheaper than it had been in the late 1990s through the early 2000s.

The other thing that has gotten General Electric in trouble has been the performance of GE Capital. The excessive leverage that the finance unit took on leading up to the 2008-2009 Recession. A conservative dividend stock with GE's longstanding reputation simply was not supposed to experience that kind of trauma, and the dividend cut inspired by GE's liquidity freeze during the recession justifiably discouraged investors from owning an industrial conglomerate that had deviated from its historical excellence.

But the funny thing is that, even during the depths of the Great Recession, GE remained an industrial powerhouse. The company managed to generate over $2.07 in cash flow per share over the course of 2009. The company traded between $5.70 and $17.50 that year. That means that GE generated a cash flow yield of between 11.82% and 36.31% over the course of 2009. The economic reality of GE's industrial base remained strong - the crisis in GE stock was all about liquidity.

Today, GE Capital only uses ¼ of the amount of leverage that it did in 2007, and that should be good news for conservative investors trying to get a handle on the company's risk adjusted return potential over the next five and ten years. GE is shedding its low quality real estate operations from its portfolio (particularly in Australia), and is diverting retained earnings primarily towards the $200 billion industrial backlog. For someone looking to GE shares for the purpose of generating high-quality dividend income over the next five to ten years, that should be an encouraging sign.

Let me show you what I mean. General Electric's last two dividend payments have been $0.19, and the two payments before that were at $0.17 per share. At first, that sounds like a puny amount. Just two little cents. But look at what happens if you adopt a business owner's mentality, takes the cash generated from his GE stock, and plows them back into more shares of the industrial conglomerate, allowing him to expand his ownership position and receive even more dividends in the future.

Let's assume our hypothetical GE investor rolls like a boss and purchased 1,000 shares of GE a year ago at a price of $20.37, costing him $20,370 plus a modest $8-$10 trading fee in most circumstances.

The company's past year of dividend payments go as follows: two payments of $0.19 per share that would have gotten reinvested at $22.14 and $22.34 per share, respectively. And before that, two payments of $0.17 per share that would have gotten reinvested at $21.26 and $20.37 per share, respectively.

The first $0.17 payment would have generated $170 in income that got reinvested at $20.37 per share, adding 8.34 shares to the position total. The next payment would have been $171.41, which would have added 8.06 shares to the total due to reinvestment at $21.26 per share. This would bring the share count up to 1016.40 total.

By the time GE raised its dividend to $0.19 per share, we now have two compounding forces working to the investor's advantage: a dividend raise intermingling with the redeployment of GE's dividend profits getting plowed back into the firm. The $0.19 payment would have boosted the quarterly dividend income to $193.12, which at a reinvestment price of $22.34 would have added 8.64 shares, bringing our investor's total to 1,025 shares. And at the time of the most recent $0.19 dividend payment at the $22.14 mark, our investor would have added $194.75 worth of income to his position, meaning he now owns 1,033 shares of GE due to one year's worth of dividend increases and reinvestment.

That 33 share addition was all passive. You provided the upfront capital to make the investment, and then sat back and let the profits drown themselves in more shares of General Electric. That's why an investor can get excited about a seemingly small two cent increase in a company's dividend payout. Our investor went from generating $680 in annual income this time last year to generating $785 in annual income today. That is an increase of 15.44%. Breaking it down further, 11.76% of that came from the most recent dividend growth, and 3.68% came from the short-term power of reinvested dividends.

This is a classic short-term case study of what makes dividend investing lucrative on even a short-term basis. If you think like a trader, it doesn't seem like GE does all that much: its shares just bop around in the low $20s and the $0.02 dividend increase doesn't seem like anything to do cartwheels over. And then you do the math and see that you got a 15.44% dividend increase just for being a passive receptacle that happened to click "reinvest dividends" on your brokerage account and letting GE do the heavy lifting of drowning you in cash from there. And that is just one year of reinvested dividends and dividend growth. Imagine what the numbers will look like when it becomes ten years, twenty years, even thirty years of washing, lathering, and repeating the process.

Immelt has made it clear in the annual report that returning capital to shareholders will be GE's priority over the next five years. Investors with a memory may be shying away from GE because Immelt famously said that "the dividend is safe" five years ago shortly before cutting the dividend from $0.31 to $0.10 to shore up capital to weather the financial storm.

My personal conclusion is that management's word can only be as strong as the underlying strength of the enterprise in question. And right now, GE is a much stronger company today than it was in 2008. It's becoming "Your Daddy's GE again." The company has outlined a plan to shrink GE Capital, and has already begun the process of selling off GE Capital's most troublesome assets. Also, GE Capital is truly a wonderful business, and its reputation is perhaps unjustly maligned because of the excessive leverage in the capital arm during the 2007-2008 period. Because GE Capital's leverage has been reduced by over 70%, GE is better prepared for an economic downturn today than it was five years ago. And, of course, there is the $200+ billion backlog. Industrial profits are growing by over 7% on a currency neutral basis, and that is going to fund future dividend growth for the firm.

Although the other S&P 500 companies are thankfully starting to come down in price so that those of us interested in initiating positions in excellent companies may actually do so at a reasonable price, many of the high-quality stocks are still trading above their ten-year P/E ratio averages. General Electric is one of a small handful of high-quality dividend stocks sitting right in front of us. For high-quality dividend growth at a reasonable (maybe even slightly undervalued) price, GE ain't a bad place to look.

Disclosure: I am long GE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.