Forgiving General Electric’s Dividend Cut And Lofty Executive Compensation

The funny thing about GE’s dividend cut during the financial crisis is that it actually freed up capital to allow General Electric to recover faster and stronger than it would have if the $0.30 quarterly payout had to be maintained. Additionally, it is the presence of a high-quality executive base (that happens to get paid very well) that is largely responsible for being able to grow profits 8-12% annually despite being a monolith that brings in $146 billion in revenues. We’re talking about lightbulbs, water processing, and engine construction here. This isn’t like Coca-Cola where you can just twiddle your thumb and the annual growth happens automatically due to the ubiquity and brand equity of the product.

Managerial excellence is an important ingredient in GE’s long-term success, and paying people well is important to keep talent. Although it’s currently fashionable to trash GE’s credit division (and with the destruction it wrought in 2008-2009, I get why), it is easy to overlook the fact that the credit assets are usually quite lucrative.

After the upcoming finance division spinoff, I have no idea which of the two securities will outperform. The risk to the credit divisions has always been overleveraging to goose returns, which is the Achilles Heel of finance stocks in general (if you are humming along in a low risk way growing 6% each year safely while your peers are growing at 11% annually, you will lose your job eventually, even if you are laying a foundation equipped to handle 2008-2009 type of situations in a way that your competitors are not). This “penalty for safety” is one of the worst incentive structures that exists among corporate management firms in big-name financial stocks, and it explains the difference between why I could sleep comfortably having my entire net worth in Coca-Cola, PepsiCo, Clorox, Colgate-Palmolive, and Kraft, but not Citigroup, Bank of America, and AIG. It all has to do with the amount of debt involved, and the perverse incentives facing the executives of finance-focused corporations that still prevail to this day.

An idiot replacing Ajit Jain at Berkshire’s Reinsurance Division can wreak disaster in a way that an idiot running Kraft cannot. If someone incompetent runs Kraft, the worst thing you have to deal with is a great pizza business getting sold off and undervalued stock being used to buy a British confectionary firm. That might hit your profits 10%, but you’ll survive and thrive just fine in the long term. With finance stocks, the ultimate consequence is a swift, unanticipated total implosion because of a liquidity freeze or the collapsing tower of overleverage that can turn millions of dollars in stock ownership into $0.

In short, GE’s financial divisions are excellent wealth creators with low capital requirements when they are well managed. But the consequences of poor management are far greater for GE Credit than GE’s industrial divisions.

The dividend cut and the poor risk management of 2008 and 2009 were terrible events that retirees and income investors had to address. But you’re not “sticking it” to the malfeasors by refusing to invest in the company now. The earnings and dividend growth prospects going forward are quite nice, and the price is fair.

It’s not going through your investing life with perfect justice, perceived fairness, or no harm that is the key to success. Rather, it is maintaining a cool head, acting rationally, and sizing up opportunities even after getting screwed (heck, especially after getting screwed) that will separate you from pedestrian investors that get mocked by the elite.

If a “What is the most intelligent thing I can do right now, regardless of the past?” temperament is maintained over a long enough time with a wide enough stable of high-grade investments, the end result is that you have so much money coming in regularly that you get to live the life you want, on your own terms. Owning GE now after getting burned is just one example of that theory meeting reality.




Originally posted 2014-01-15 01:38:47.

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