GE Vs. 3M - A Different Take On Dividend Growth

| About: General Electric (GE)
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Summary

General Electric (GE) shareholders have seen diminishing benefits in holding the stock as a dividend position with diminishing generosity in the dividend hikes.

The surprisingly large and contrasting generosity seen in 3M (MMM) dividend raises is overdue but sustainable for the short-term.

Still, MMM is overpriced as per its discounted cash flow valuation and should be entered with care via options.

An advantage of investing in industrial stocks is that you do not need to study the macro environment for these stocks: Industrial stocks are the macro environment. In essence, your position in industrial stocks broadcasts your thesis on the direction of the American macro environment in general. Of course, some industrial stocks are positioned to outperform the market, while others will embody the risks of the macro market without paying you for exposing yourself to those gains.

General Electric (NYSE:GE) and 3M (NYSE:MMM) are two industrial stocks requested by my subscribers as the subjects of a comparative dividend analysis: Assuming the US macro market holds strong, which is the better dividend stock? The dividends of both choices are roughly equivalent, giving investors a reliable, moderate annual yield of 3.44% for GE and 2.38% for MMM. However, that is where the similarities end.

Low yields typically are matched with dividend safety, but the track record of MMM's dividend is stronger, showing 58 straight years of dividend per share (DPS) growth. Investors in GE have had access to 100 years of dividends, albeit not without a couple cuts. Debates centered on this topic might emphasize the length of the track record over the consistency of the track record, but the tradeoff in selecting one of these stocks is not so trivial: The underlying fundamentals and balance sheet characteristics show more drastic differences between the companies and contain the answer to which of the two is better suited for your portfolio.

In fact, the binary issue of whether the dividend has a cut in its history is superficial when compared to the reliability of the resources from which the dividends come. The percentage of net profit eaten by the dividend and the "generosity" of the dividend raises have much more to tell dividend investors. Dividend increase generosity is an often overlooked aspect of forward dividend growth expectations in light of sustainability of that growth.

For GE, we see the company in the midst of returning to glory. The projected path to hitting new DPS heights has slowed due to a reduction in "generosity." Perhaps the company is in no rush to place itself in the risky payout situation that had originally led to the dividend cut:

I see this as natural in light of the current payout concerns. Note GE, on the left, has much more reason than MMM, on the right, to act with restraint in determining the magnitude of its dividend hikes (the left/right order of GE/MMM will hold for similar images later in the article):

The upper limit for dividend hikes has a direct effect on GE's stock price, once you notice the strong correlation between dividend movement and stock price movement:

Dividend stocks tend to have the connotation of being relatively lower risk, but the mere issue of maintaining investor satisfaction in the speed of dividend increases adds an additional risk element. When that risk appears to be low due to strong profits and reliable management, it is all the more impressive. Ergo, the generous dividend raises in MMM should be seen as more than just a benefit to the investors: It is an indicator of business strength:

However expensive these hikes were for the company, they did not go unappreciated; the stock has kept pace:

In the "generosity bear market," GE is not without recourse. The free cash flow might be negative in the short-term:

But the company has plenty of cash on-hand. This is why we always look at running averages of cash flow instead of point-by-point cash flow:

GE has the reason and the resources to become once again generous with dividend hikes, but to do so would still be irresponsible because of volatility in the company's underlying metrics. The financials of GE and MMM, once compared, shed light on how and why MMM can bring up its yield quickly and reliably, whereas for GE the same action would imply a significant risk to the cash flow:

Over consistent cash flow expectations and realizations, MMM can continue to leap where GE merely steps: The dividend hikes are supported by reliable growth for MMM but only postulated by analysts for GE. Analysts should not be surprised here, as MMM's dividend has underperformed the industry for quite some time and because the phenomenon of mean reversion applies to dividends as well as stock prices.

The end of a mean reversion trend is when the metric of interest reaches the average, sometimes overshooting. But not all reversals are so natural and free; the "ceiling" mentioned in one of the images above is hit in real-world situations. The real world cannot sustain the mean reversion in MMM's dividend once debt becomes a serious concern:

While MMM's debt is becoming an increasingly important issue, GE is improving its balance sheet. And here we see the cycle of life - or dividends, rather. To own GE over MMM or MMM over GE throughout eternity is silly, as both will witness periods of outperformance.

If the US macro environment is held constant, MMM's dividend growth should continue at an advanced rate and hence be the more appealing stock for investors seeking that particular form of investment. Nonetheless, MMM is trading at a significant premium to its discounted cash flow valuation:

Overall, if you are impelled to hold one of these stocks over the other for the sake of dividends, do it with MMM. But do it intelligently. Use options to limit downside risk and enter a stock position via exercise before the ex-dividend date during a time in which you feel the macro environment is reliable. (However, if your options are highly profitable, you might want to just take profits via selling, and return to the strategy room to redesign your entry point, if still valid after such a rally.)

I would do this with long ITM call options (many have been asking me my preference for ITM calls instead of OTM calls, and I've responded with a detailed video, which you can see below). Here's my recommended form of entry:

Buy Jul21 $190 call

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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.