General Electric's (NYSE:GE) repeated promise to sustain its dividend streak has not come absent doubts from investors, who following the 2008 recession, were hit with a monumental slash in dividend payouts when GE's annual dividend slipped from $1.24 per share in 2008 to $0.61 a share in 2009, a more than 50% decline. While GE has managed to consistently increase its dividend ever since 2009, its promise to not only continually do so going forward, but ultimately offer a payout and yield similar or greater to precession levels has been taken with some grain of salt. Investors believe that a dividend bigwig like GE ought to have a decisive plan that safeguards fairly consistent dividend payouts to shareholders, even in the face of major economic shocks.
From this viewpoint, one can understand why investors are demanding detailed presentations from GE that comprehensively elaborate how it will sustain its prevailing dividend streak. Investors want the kind of presentations that use advanced graphs, recondite yet reassuring financial formulas, and other number crunching techniques that can make even Warren Buffet scratch his head in momentary frustration.
While GE is certainly obliged to provide tremendously detailed reassurances of how it will maintain its prevailing dividend streak, the process of issuing lengthy reports is too tedious and not to mention, potentially telling of its core strategies to competitors. Notwithstanding, GE has not necessarily ignored investors' call to give detailed reassurances of how it will preserve its prevailing dividend streak. In fact, it has cleverly sent repeated and clear signals that it will not only increase dividends, but that this time, it has a full proof insurance policy against any potential economic shocks that may perturb its increment streak.
GE Capital should comprise a third of earnings by 2015, says Immelt
GE CEO Jeffrey Immelt previously said that GE Capital, GE's financial segment, would comprise around 30% of earnings by 2015, down from 40% in 2013 and 45% in 2012. This statement has been repeated time and again albeit with little reference to the tremendous meaning it carries. Its pithiness is only rivaled by the monumental role it plays in securing GE's promise of increased dividends.
GE Capital is a highly leveraged segment; that we know. In fact, Synchrony Financial, a new business up for IPO that will absorb GE's North American consumer credit card business in order to reduce GE's overall exposure to GE Capital, will take on some of GE's highest concentrations of credit risk.
GE's reduced exposure to a highly leveraged segment greatly enhances its promise of continued dividend increments. This is because the cost of credit will increase significantly going forward. While the Fed has said that it will probably hike interest rates next year, new figures suggest that this could happen sooner, despite the Fed downplaying this particular speculation. A growing body of compelling research from renowned economists, including Alan Krueger, who chaired President Barack Obama's council of economic advisors until August, proposes that wage inflation could soon increase because short-term unemployment has decreased significantly in past months and is now all but close to the US natural rate of unemployment, which is the lowest rate of unemployment an economy can sustain before inflation rises. Most estimates place the natural rate of unemployment in the U.S. at a figure between 5.5% and 6%. While the current unemployment rate of 6.7% is still about a percentage point above the natural rate of unemployment, increasingly positive economic data suggests that unemployment could fall faster than anticipated, putting upward pressure on wage inflation and prompting the Fed to hike rates earlier than predicted. When this happens, the cost of credit will undoubtedly rise, and GE will be glad it reduced its exposure to GE Capital, along with the highly leveraged pockets within the segment—such as the one Synchrony Financial will gobble up—early enough.
Consider that GE Capital is a highly leveraged business. More costly credit induced by impending rate hikes will thereby suppress GE's overall profit margins, crippling the ability to increase dividends. The move to reduce exposure in GE Capital thereby screams of a well planned pre-emptive measure aimed at averting high costs in the future, which is good as far as preserving GE's promise of increased dividends is concerned. This is because profit is equals to revenue less costs. Thereby, the more you suppress the latter, the higher your profit, and the easier it is to continually and sustainably increase dividends.
After taking a closer look at what Immelt's statement regarding GE's commitment to reduce exposure to GE Capital means for its overall dividend strategy, one can't help but appreciate the power of succinctness -- it tells a great deal in an almost artistic degree of brevity. By following through on the commitment to derive less of its earnings from GE Capital, GE will be able to put a reasonable cap on its overall costs, allowing it to preserve profit margins at sufficient levels essential to the frictionless financing of operations and the continual increase in dividends. What a clever little insurance policy GE has to protect its promise of continued dividends.
Lennox Yieke has no position in any stocks mentioned. The Motley Fool owns shares of General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.