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:
1. The GE portfolio could be too large,
2. Dividend payments are not sustainable.
There has to be a new strategy.
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..
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.
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.