If I come up with an intelligent investment idea, the ultimate value of the the idea hinges upon my ability to actually put up funds and make an investment in the business that I believe will deliver excellent long-term returns. What is the old Mark Twain quote? Something like: “The man who can read but chooses not to read exercises no advantage over the man who cannot read.” Maybe there is an investing corollary to that: “One who can identify great long-term investment opportunities but does not actually put money into them exercises no advantage over the one who cannot identify great long-term investment opportunities.”
Like the great majority of individual investors, I do not make a single lump-sum investment at one point, but rather, accumulate shares of a given stock over time as surplus capital from labor becomes available.
This leads me to an important conclusion: When I identify a promising investment, I do want the price of the stock to go up in the near term. I want it to decrease in price as I accumulate shares so that the value of my insight can maximize its value. If I correctly identify that stock X is worth $50 in 2025, I benefit from shares drifting from $20 to $15 over my accumulation period rather than $20 to $25. The assumption for this to be true is that my inputs must be static–i.e. the business must truly be worth $50 and any fall from $20 to $15 benefits the accumulator best when there is no actual deterioration in the business model.
Of course, the pitches that the real world throws at us are never quite so simple. Often times, the deteriorating stock price is accompanied by legitimately bad news, and the investor must determine whether the magnitude of long-term prospects still remains high after the true business value is whacked down.
These thoughts ran through my mind as I saw the news that General Electric’s CEO predicted no increase in profits to GE’s power division in the near-term and would not commit to maintaing the $0.48 per share dividend in 2019.
My strongest disagreement with the traditional dividend growth community at large relates to the question of whether a stock should be sold when a dividend cut occurs or is at least contemplated. I cannot endorse the viewpoint that stocks that cut their dividends should be sold. The valuation of a business when a dividend cut is in the air often becomes so cheap that it forms the basis for an excellent value investment and the possibility of high dividend growth as the problems are sorted out and the lower dividend base provides a platform for growth.
In my own writing career, this had been most evident when BHP Billiton cut its semi-annual dividend from $1.24 to $0.28 in 2016. By that point, the stock price had fallen from $93 to $18. The valuation was just so low that even satisfactory future performance meant excellent medium-term returns for those who opportunistically acquired. Today, BHP is back to $47, and the expected dividend payout for 2018 is somewhere around $2. He who struck when BHP collapsed is now collecting 11% in annual dividends on the initial investment in 2016.
I view General Electric in this current range, at $14 or lower, as analogous to purchasing BHP Billiton when the dividend cut was weighing on the stock. GE has already fallen from $33 to $14 over the past two years. The valuation has more than priced in the potential for a dividend cut.
The upside is that the opportunistic investor can strike now and set himself up for unusually high capital gains and high cumulative dividends over the coming five years. At a price of $14 per share, the bad things about GE can largely be true and the business can still be primed for success.
General Electric made two big mistakes. When it owned extensive financial operations, it did not adequately capitalize the business with cash reserves to absorb the typical fluctuations in business performance that occur year-to-year (and as a result, was woefully underprepared for the last recession). Then, when it sold the financial operations, it did not adequately rebase its dividend to readjust for the fact that stock repurchases alone could not shore up the loss of very lucrative profits from former lending and credit subsidiaries that were only auctioned off at a valuation like 8x earnings.
General Electric owns businesses that generate torrents of cash, but has maintained a balance sheet in need of a deep cleanse. Bank of America has recovered so strongly, to the point that some now consider it superior to Wells Fargo, because it maintained years of billion-dollar profits when it was only paying out those penny per share dividends that allowed the balance sheet to readily repair itself.
If GE doesn’t cut the dividend, there will probably be a slogging road to recovery. If the dividend is cut or suspended temporarily, it can use the $9 billion annual profit engine to shore up the balance sheet and regain its position of strength quickly.
If GE fell from, say, $30 to $25, on the news that a dividend cut was being contemplated, it wouldn’t be worth of an investor’s response because the road to recovery would not be well-compensated. But that is not the case. The stock is at $14. When a business earning $9 billion trades at a $120 billion valuation rather than a $250 billion valuation like it enjoyed less than two years ago, the investor is going to be paid quite well to delay income today in the pursuit of the business coming to resemble the GE of old a few years from now.
In a non-recessionary environment, it is not difficult to foresee GE earning $2 per share in 2023. In the event of high oil prices, or at least, demand for high-powered machinery to be used in the oil sector, those earnings could be as high as $25. That augers very well for a $14 stock. I think GE will be paying more than $1 per share in dividends in 2023 and those who buy the stock today will reap strong capital gains and earn a high yield-on-cost compared to their current capital outlay if they buy and reinvest. If I had to bet on it, General Electric will exist in some form as a profitable enterprise throughout the remainder of my lifetime. I would only say that about 50 or so businesses out of the 15,000 that are publicly traded.
This is a publicly available version of an article shared with The Conservative Income Investor’s Patreon followers on May 23, 2018.