Well, the hammer finally dropped. General Electric (GE 2.10%) has cut its dividend by 50%, from $0.24 per share to $0.12. And the percentage isn't the only thing that's huge about the news.
This is the second time in a decade that GE has cut its dividend... and also only the second time since the Great Depression. That has to make current investors concerned, particularly since GE's rivals Honeywell and United Technologies haven't had to cut their dividends since the 1990s.
But in the wake of a collapsing share price and declining earnings, a dividend cut may actually be a good thing for General Electric. Here's why.
Storied industrial conglomerate General Electric has fallen on hard times lately due to a trend of underperformance. Image source: Getty Images.
1. An end to uncertainty
Ever since new CEO John Flannery took over from Jeff Immelt this summer, speculation has been rampant that he would cut the dividend... or possibly break up the company altogether. Flannery did an admirable job of playing his cards close to the vest, saying he would need to perform a thorough review of the company's operations before making any decisions.
In the meantime, the stock price continued to fall, pushing the dividend above 4%, then above 4.5%. While GE was still able to cover its dividend, it was relying on payments from its GE Capital arm to do so, and many analysts pointed out that such cash could be better deployed elsewhere in the company.
The dividend debate reached a fever pitch ahead of GE's Q3 earnings report. And Flannery -- to the surprise of many -- opted not to cut it... at least, not right away. But any potential upside to this decision was wiped out by GE's underwhelming earnings and a reduction in full-year guidance. That sent the stock price tumbling to about $20 per share, where it's hovered ever since.
Now that the dividend has been officially cut, it puts an end to this five-month "will-he-or-won't-he" period of uncertainty for investors. And as we all know, the stock market hates uncertainty. So this actually may prove beneficial to the company's shares, because we can now be sure the market is factoring in the dividend cut and is looking beyond it to the company's fundamentals. And a calmer, more rational approach to GE's situation will be a breath of fresh air after months of hysteria.
2. Back to normal
It's helpful to put this latest move in context. GE's first dividend cut since the Great Depression came in 2009, as its financial and consumer credit arm, GE Capital, was being decimated by the Great Recession. The company cut its quarterly dividend from $0.31 per share to just $0.10 per share. That knocked the annual yield down to just under 3%, in line with what the company had historically offered. Of course, that was cold comfort to investors who saw their $40 shares drop to less than $10 apiece in reaction to the move. But it did free up much-needed cash.
Since the recovery, GE's dividend has mostly hovered between 3% and 4%, as the share price climbed back to above $30 per share. But the company's disastrous 2017 has boosted the yield to almost 5% as shares have dropped below $20. This new cut to a quarterly $0.12 per share would represent a 2.4% yield at a stock price of $20: low by GE's historical standards, but a reasonable dividend for a large industrial conglomerate. GE's rivals United Technologies and Honeywell currently yield 2.3% and 1.8%, respectively.
So, returning the dividend to a more manageable level will probably be good for the company.
3. Freeing up cash
When a company like GE starts spending too much of its cash on dividend payouts, it may make investors happy, but that comes at a price. The company has less cash to devote to researching and developing new products. It has fewer resources to pursue restructuring efforts. Or market its products.
It also may be reluctant to shed underperforming businesses that bring in lower-margin revenue. If a company needs every penny to maintain its dividend payouts, it may feel obligated to hold on to every scrap of revenue it can to avoid a cash crunch.
By cutting the dividend, Flannery has given himself some flexibility to jettison some revenue streams and pursue restructuring efforts. Indeed, he has already announced that he's looking to sell GE's transportation and consumer lighting businesses. This would free up resources that can be used for R&D or marketing, or other efforts that would improve GE's overall business model.
It's not going to win Flannery a lot of friends among income investors, certainly, but it will probably save him more than a few headaches down the road.
What it means in the long term
A dividend cut isn't going to be good for GE's shares in the short term, and indeed, the share price has dropped more than 5% on the morning of the announcement. That said, the fact that it didn't fall further indicates that a drop was already partially priced into the stock.
Long term, however -- which is how we at the Fool recommend looking at your investments -- the dividend cut is probably a good thing for the company. It ends the uncertainty of whether Flannery will cut the dividend and returns the yield to historic and more-manageable levels. Most important, it frees up company resources so that Flannery can implement restructuring and a corporate agenda that will hopefully get GE back on track.
Make no mistake: It's likely to be a rough couple of years for GE investors as Flannery tries to sort everything out, and there's no guarantee he'll be successful. But now that the dividend cut is over and done with, it may be that the worst is over. Even though it's tough to do, long-term investors should probably hang on to their shares and hope for the best.
