Question

ISSUE: Should we pay dividends?

PRELUDE: Over the years, General Electric [GE]the firm has performed well and now (mid 2017) they have a new CEO. The handsome dividends paid in the past maybe cut by 50%. GE is now at the stage that it is overextended – this poses two problems:

The GE portfolio could be too large,

Dividend payments are not sustainable.

There has to be a new strategy.

INFORMATION.

Academic studies:

John Lintner a Professor at the Harvard Business School in the 50’s, through interviews, gathered that investors prefer dividends and that CFO’s have a target payout ratio that they wish to achieve in the long run.

Miller & Modigliani (of capital structure fame) in a seminal paper show that dividends are irrelevant. Investors who wish for a dividend can adjust their ownership in stock. They go on to say that, dividends at the least, must be a byproduct of their capital investment policy, which essentially means do not forego positive NPV projects..

          Practice:

Firms may choose to use funds and pay dividends.

Firms may wish to avoid establishing a cash paying policy thereby, not creating an expectation in the market. A share buyback will be appropriate.

Non-cash dividends can be stock splits or stock dividends.

          What we know:

Aggregate payouts are big and increasing.

A small number of large and mature firms pay dividends.

Managers are reluctant to cut dividends.

Managers smooth dividends.

Stock prices react to unanticipated changes in dividends.

Financial projections:

I have constructed pro forma Income and Balance Sheet statements. Using very restrictive assumptions to some optimistic ones, I can safely state that GE has to rethink its position.

GE has too many business interests in many segments.

Some lines are not as profitable as others.

IF some lines are sold and the GE gets a ‘new’ focus, then, it may need make sure it has an adequate cash flow to service debt.

GE has to rethink its dividend policy.

The long run prognosis for GE is good. Only an event like a casus fortuitus will prove me wrong. The firm will end up with a cash surplus in the future.

          Data:

Shares outstanding            --        8.732 million as of Sep. 2017

Price   high/low 2017          --        $ 17.25 - $ 31.45.

Future dividends                --        $ 0.48.

Cash/share                        --        $ 1.48.

Div. yield 2017                   --        3.3%.

Payout (2017)                    --        111%.

Forward P/E                      --        18.3.

?                                       --        0.89

Answer 1

In this case paying dividend can be ignored because the present scenario is overextended and dividend payment is not certain. Also, if required dividend can be paid in form of share buy back etc. Presently they are not certain about the debt service also. It will be good for GE to sell the not profitable lines, service the debt effectvely and more focus on profit making line. By selling the non profitable entities and paying dividend is not relevant, when debt service is a concern. GE Must think about the positive NPC projects.