With GE (NYSE: GE) having a forward yield of 3%, it is clear to see why it holds appeal as an income play for many investors while the S&P 500 has a forward yield of just 2.2%. Furthermore, GE has historically been a relatively stable and resilient business, with its conglomerate structure providing diversity during uncertain economic circumstances.
For example, it has had an industrial as well as financial arm and this defensive nature has appealed to many income-seeking investors over a long period of time. It has also made it a popular choice at a time when interest rates have been low and macroeconomic uncertainty has been high. And with GE having almost doubled dividends during the last five years, it is clear as to why it has proved popular among dividend investors in the recent past.
However, the company is now undergoing a major transition as it seeks to become a more industrial-focused (rather than financial-focused) company. We think that this should not alarm income-seeking investors, but rather allow GE to deliver strong capital gains alongside a top notch yield moving forward.
A key catalyst to push its share price higher is the fact that GE will be a more collaborative entity in the long run. While a conglomerate structure can provide defensive attributes, it can also lead to inefficiencies since there may be little crossover between the company's divisions. GE is therefore set to become increasingly efficient and deliver synergies as it seeks to pull its different divisions together via the GE Store, which is where ideas regarding technological progress and innovation are shared between different parts of the business. This should allow GE to become a more nimble and innovative business capable of operating in a faster moving industrial world. We think that the greater efficiencies resulting from the GE Store could boost the company's profitability and share price.
Furthermore, GE's turnaround plans are set to position it as a more focused growth play. The company's decision to pivot from financial services to industrial operations could in itself have a positive impact on profitability since the return on capital for GE's industrial segment is far higher than its cost of capital. However, in its financial segment the cost of capital exceeds the return on capital. Therefore, by simply transitioning from financial to industrial it should equate to higher profitability even without the greater efficiencies previously mentioned. We think this higher level of profitability could be a key catalyst and driver of GE's share price moving forward.
We're also bullish about GE's capital gain potential because of its international operations. While they suffered from a stronger US dollar in recent years, we believe that the US dollar will weaken moving forward and this could positively impact GE's share price. That's because the Federal Reserve is now much more dovish than it was last year and is therefore planning fewer interest rate rises and at a slower pace. For a company with operations across the globe, the impact of this policy change could prove to be significant on its earnings and share price.
A further potential catalyst on GE's share price is synergies from the recent acquisition of Alstom. It shares a number of customers with GE in different product lines and this could help to make the company's integration smoother and allow it to add to profitability faster and in a bigger way. This could aid margins yet further and boost GE's profitability and share price moving forward.
Of course, with major change comes increased risk. Investors in GE who have valued its diverse nature and relative stability may be understandably wary regarding its decision to focus on the industrial space in future. While it may end up being less diverse than in the past, GE looks set to become more profitable and we feel that this could benefit cash flow and dividend payments, thereby allowing the company to increase dividends at a rapid rate in future.
And while there is a danger than GE will be unable to successfully integrate its acquisitions and the pace of change may be slower than planned due to short-term challenges, we believe that the potential rewards from the changes GE is making make those risks worth taking. In other words, the company's risk/reward ratio remains appealing and for income investors, the prospects of increases in dividends is brighter given the company's transformation plans.
With GE trading on a forward P/E ratio of 17.6, it trades at a premium to the S&P 500, which has a forward P/E ratio of 17.1. However, we think that it is worthy of such a premium given catalysts such as its potential to become a more efficient business, the scope to deliver significant synergies, the prospect to benefit from a weakening US dollar and its pivot towards the faster growing and more profitable industrial sector. And with a yield of 3% as well as dividend growth potential, we think that GE remains a top notch income play with strong capital growth prospects moving forward.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.