ISSUE: Should we pay dividends?

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.

INFORMATION.

Academic studies:

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..

           Practice:

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.

Financial projections:

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.