As General Electric (GE) continues to shed its financial assets (after eliminating most of its low-quality assets tied to real estate, the company is now spinning off its private label credit card operations worth $15-$20 billion), the company is becoming easier to analyze for dividend growth purposes because of its renewed focus on industrial activities (think engine and aviation production, water processing, medical device manufacturing, household appliances, oil and gas, and transportation construction).
And as we look to make determinations about a post-recession GE without a strong financial presence, we can see that the company has the ability to create about 8% ongoing earnings per share growth from its industrial divisions. You can explain the first 6% of the annual growth by looking to GE's ongoing efforts to work through its ongoing $200+ billion backlog, and the other 2% annual growth will come from (1) GE's plans to cut costs by $2 billion or so per year, and (2) GE's acquisitive habit of making $5 billion or so worth of bolt-on industrial acquisitions per year.
When we try to figure out how this will affect General Electric's dividend policy going forward, the questions we have to ask are: (1) Does General Electric have meaningful room to expand its payout ratio? And the other question is: (2) What will be the company's earnings per share growth rate over the medium term when we tally up the base rate of earnings per share growth in addition to share count reductions caused by stock buybacks?
Right now, General Electric is pumping out $1.65 per share in profits for shareholders (although some stock screeners understate GE's profits at $1.40 per share by factoring one-time events associated with asset shedding that will not be impairing GE going forward). Taking into account GE's recent dividend hike to $0.22 per share quarterly, GE's annual payout of $0.88 per share represents approximately 53.3% of ongoing profits. Normally, GE's returns approximately half of its profits to shareholders as a dividend, although the payout ratio has spent some years around 60% of profits in "normal" economic times historically. Although the recent 16% dividend hike was nice, expectations about dividend growth going forward over the next five to ten years ought to closely mimic the company's earnings per share growth rate over the time frame.
That leads us into the second question: What will be the company's earnings per share growth rate when we factor in the stock buybacks as well? Once we adjust for the higher than usual buybacks at GE that resulted from the sale of NBC, we can see that GE is now buying back stock at an average rate of about $2 billion per quarter, which at the current price of roughly $27 per share, results in an annual share count reduction of almost 3% annually.
This is what makes GE such a compelling buy going forward for investors that focus on the growth in income: GE has the infrastructure in place to give investors dividend growth of around 10% on average for the next 5-10 years because the company is growing profits by 8% annually when you take into account the pace at which GE is addressing its $200 billion backlog, and then factor in the $2 billion annual cost cuts in combination with the $5 billion or so in annual acquisitions that seems to be ingrained in the DNA of GE's long-term growth strategy.
But the company's commitment to buying back $2 billion per quarter in stock gives GE the ability to add another three percentage points to its earnings per share growth rate, and this is what is going to allow GE shareholders to experience dividend growth closer to the 10% range over the coming five to ten years rather than around 7% or so in congruence with its regular earnings per share growth rate without accounting for buybacks.
The catch, if you will, going forward is that GE's price could rise significantly in the next year or two, weakening the effectiveness of the buyback program. If, say, GE had to buy back its shares at $35 per share rather than $27 per share, then the buyback may only add 2% or so to the earnings per share growth figure. Somewhat paradoxically, the lower GE's stock price over the coming years, the more cash GE will have available to return to shareholders in the form of dividends. But if the price of the stock does not increase rapidly, then it seems that GE has the infrastructure in place to give shareholders dividend hikes that come within the ballpark of 10% annual dividend growth due to the combination of 8% "regular" earnings per share growth combined with another 3% stimulated by GE's ongoing buyback program.