General Electric is Dressed to Please but You have to Sell it Now

DSR Quick Stats

Sector: industrial

5 Year Revenue Growth: -4.73%

5 Year EPS Growth: -31.80%

5 Year Dividend Growth: 14.87%

Current Dividend Yield: 3.06%

What Makes General Electric (GE) a Good Business?

First, a company with an emblematic founder named Thomas Edison. Second, a company that has been around for over one hundred years and that has been paying dividend for a century to its shareholders. Third, a company with an enormous portfolio of products and services operating across the world. The company counts 8 division among their “GE Store”:

  • Power: combustion science and services, installed base.
  • Energy connections: electrification, controls and power conversion technology.
  • Renewable energy: sustainable power systems and storage.
  • Oil & Gas: services & technology.
  • Transportation: engine technology and localization in growth regions.
  • Lighting: LED bulbs.
  • Healthcare: diagnostics technology.
  • Aviation: advanced materials, manufacturing and engineering products.

Which such a resume, you would think that GE should be the perfect holding for any dividend growth investors, right? The company is certainly a big player in several markets, but the drop of 31% of its earnings over the past 5 years concern me. Let’s dig further.



Revenue Graph from Ycharts

Since its record year in 2009, the company has been suffering greatly. The problem is that GE has become definitely too big to being handled properly. Several segments underperformed and wasted cash and human resources. Management has finally woke up and put effective measure to reposition their massive brand portfolio and show interesting perspective in the past couple years.

How GE fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.


Source: Ycharts

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.


Source: data from Ycharts.

General Electric has posted a steady dividend yield around 3% over the past decade (excluding the short peak in 2009 following the recession). It is important to point out the dividend cut in 2009 as GE Capital business went south due to the 2008-2009 credit crunch. After this dark year, the company has put everything in place to grow back its dividend to its previous level.

GE meets my 1st investing principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?


Source: ycharts

As I mentioned in the previous chart, the dividend payment as greatly cut in 2009 bringing back the distribution past the 2000’s level. Since then, GE has made a honest effort to compensate their shareholders through 14 Billions in share repurchase and 4 Billions in dividend payment. Unfortunately, as the economy has slowed down in the past 18 months, GE is struggling again to post dividend growth.

GE does not meet my 2nd principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.


Source: data from Ycharts.

When you look at both payout and cash payout ratio, you understand why management has to remain cautious about their dividend increase. The payout ratio is steady high around 80% for year and the cash payout ratio is currently deep in the red. The company doesn’t show strong ability to sustain their payouts through the long haul.

GE doesn’t meet my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

I think it’s unfair to judge General Electric solely on its metrics. The company still show several positive points throughout its business model. GE has made lots of effort to aligned its various segments in order to create additional synergy. GE is offering more services to its partners and customers in order to assist clients in buying and using GE products. There is definitely room for growth in this area.

The second growth vector GE presents is its strategy to develop the Chinese market. The country will continue seeking for renewable energy, more mass transportation and affordable healthcare due to the size of its population. Those are all areas GE can play a role. For this reason, the company is heavily implementing activities in this region and also works through partnerships with Chinese company.

What General Electric does with its cash?

GE management is well aware they must do something to keep their investor on board. This is not by fluke they have used 18 billions to repurchase shares and hike their dividend in the past few years. GE is also investing massively in their R&D departments in order to keep their edge against their competitor. Since they are active in various industries, it requires lots of cash flow to innovate everywhere.

GE is also using a part of its cash flow to make acquisitions. They have recently purchased Alstom to penetrate the European market as well as Arcam and SLM Solutions to use their technology and become a bigger player in Europe as well.

GE has a strong business model and therefore meet my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is a valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:


Source: data from Ycharts.

After declaring a loss in 2015, GE PE ratio has greatly jumped from its previous average. At this point, it seems to me that the market truly believe GE will be able to go against the current challenging environment and generate additional growth in the future. I’m not convinced enough to pay over 25 times its earnings…

By using the dividend discount model, I will have a better idea if GE, as a money distributor, worth my money. I think GE will struggle to increase its dividend over the inflation rate for the first 10 years. For this reason, I will use a 3% dividend growth rate. As a terminal rate, I will use 5% as I think the company has a strong plan and will eventually post revenue and earnings growth. The discount rate I use is 10% since GE raises various concerns at the moment.


Here’s the detail of my calculations:


Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

As you can see, GE is definitely not valued as a dividend growth stock. The market truly believes in the company and thinks it will post solid growth in the future. However, there is nothing right now justifying its current value as a dividend growth investor perspective.

GE doesn’t meet my 5th investing principle.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company  are not valid anymore, I sell and never look back.

Investment thesis

If GE is able to generate additional cross selling between its divisions and is able to benefit from future growth in China, this play will become a strong holding for many years to come. An investment in GE today is a vote of confidence in GE management team and its ability to realize its strategy. GE is big enough to reverse the current trends and post several years of growth ahead.


Unfortunately, there are a lots of “if” in my investment thesis. On the other side, the oil & gas industry is hurting GE revenue as well as the separation from GE Capital, a hectic, but highly profitable division. It will take years for others industrial segment to compensate GE Capital financial performance. Finally, GE is not generating the expected synergy with the acquisition of Alstom. It seems they have a more challenging time integrating this company to their current business model.

GE shows more risk than a strong investment thesis and doesn’t meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segment: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segment helps me to categorize my investments into a “conservative” or “core” section or into a “growth” section. I then know exactly what to expect from it; a steady dividend payment or higher fluctuation with a great growth potential.

At this time, I can see why there is an interest in GE shares. If all starts are aligned, GE could post solid financial results in a few years from now and reward their shareholders big time. However, it must be taken as a risky play, not a guarantee you will see your money grow.

GE is a growth holding.

Final Thoughts on GE – Buy, Hold or Sell?

In all honesty, GE is not worthy of my money. If I was holding this stock in my portfolio, I would sell it right now. In the industrial sector, I would rather purchase 3M Co (MMM) or Honeywell (HON) way before GE. There are too much uncertainties and too many “if’s” before getting my money back. GE plan to grow is seductive, but it’s just not enough. You can definitely find strong companies elsewhere.

Disclaimer: I do not hold GE in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

The Impact of 1%

In my latest article, I reviewed the methodology used for the dividend discount model. As I concluded, any valuation methods require a lot more than simple calculations in a spreadsheet. In order to find the intrinsic value of a share, it is important to pursue a complete analysis of the whole company. The usage of tools such as a spreadsheet could save you lots of time, but could also result in a catastrophe in your buying process if you don’t pay attention. The smallest variation of any metric could have you pass on a marvelous company or make you buy an overvalued stock at a very bad time. I will show you how a variation of 1% could completely alter the perception you have of the value of a company’s share.

In order to do so, we will start with the previous article’s assumptions for McCormick (MKC):

variation 1

Dividend Growth Rate 1-10 year – Variation of 1%

Fortunately, the first metric to determine is the easiest one and the one that has the least impact on your valuation. If we expect the dividend growth rate for the year 1 to 10 to be 7.50%, MKC intrinsic value is $96.06. However, if we are more pessimistic and determine that the growth rate should be 6.50%, the intrinsic value drops only by $7.92 to 88.14. The impact of 1% less has an impact of 8.24% on the stock price. If you are optimistic, the value climbs by $8.60 to $104.66. Then, the variation of 1% more has an impact of 8.95% on the stock price.

When I determine the value of a company share, I always keep in mind that the first 10 years’ dividend growth rate could affect the intrinsic value by roughly 10% (up or down). Since we already know that the dividend discount model is not perfect, this is a small variation compared to the power of the two last metrics.

Terminal Dividend Growth Rate – Variation of 1%

Intuitively, the terminal growth rate will have a bigger impact in my calculation. This is because we use this growth rate at perpetuity, forever. This is also the reason why I use a smaller number than the short term growth rate. I want to make sure that my calculations are as conservative as possible. With MKC, using a smaller growth rate of 6% instead of 7% brings back the intrinsic value to $68.86. This is a $27.20-dollar difference or 28.32% of the previous intrinsic value. As you can see, this makes a whole difference in the appreciation of a stock. Then again, if we boost the dividend growth rate at 8%, we have an intrinsic value of $177.67. This is an enormous difference of $81.61 more or 84.96% more than the previous intrinsic value. The simple variation of 1% up or down in the dividend growth rate could give you a value anywhere between $68.86 and $177.67. This shows you how fragile the result of your calculation is. Therefore, when you think you have found “THE VALUE” of a company, remind yourself of this example.

Discount Rate

The Dividend Toolkit Calculation Spreadsheet already includes a 1% variation of the discount rate:

variation 2

You can see that the discount rate variation is the most important metric. It amplifies all the other inputs. Then again, if you are getting too complacent and use a low discount rate, you will find the that whole market is cheap. On the other hand, if you request a 10-11% discount rate in all your analysis, you will probably not buy anything for years.

It’s a Combination of Numbers

The other thing that is very important to keep in mind is all these metrics are interrelated. Therefore, you can be very generous on the dividend growth rate and require a higher discount rate and it will almost come down to the same thing. For example, if you use a dividend growth rate of 8.50% for the first 10 years and keep it at 8% for the terminal rate but use a discount rate of 10% instead of 9%, you get a value of $96.63. It is interesting how +1% everywhere brings you back to virtually the same value, isn’t?

variation 3

variation 4

How can you make the right assumptions?

It’s impossible to remain 100% certain that you have the right assumptions. In fact, even if you are a math wiz, you can’t predict the future. Therefore, even if your assumptions are “right”, they could be hit by any storm 5 years from now. How can you make any sense from your calculations then? This is an interesting question.

I’ve solved this question by using a complete analysis process based on 7 dividend investing principles. The valuation is part of 1 principle and I also rely on the 6 others to make sure the companies I select are strong dividend payers. If the company has a strong business model and shows strong metrics, I might end-up buying at a cheap price or an expensive one, but the quality of my portfolio will be improved. To be honest, I don’t really mind about the intrinsic value of a company today, I’m more interested in its valuation 25 years from now.

Dividend Discount Model Calculation Explained

Boosted by a new confidence, the market has hit new record highs lately. Value investors must be grinning at the moment as it was already difficult to find undervalued companies at the moment, a new boost in the stock market is nothing to help. Assessing the right value of a company is quite a challenge by itself, it’s even harder when you have several years of bullish markets to improve any metrics you look at. This is why I decided to revisit the methodology used in my dividend discount model calculations.

The basics of the dividend discount model

The idea behind the dividend discount model (DDM) is fairly simple; this model considers any company as a money making machine (e.g. dividend paying). The purpose of the calculations is to give a value of all future dividend payments that will be made by this company in the future.

This assumes the company will pay & increase dividends forever. This assumption is very important as you have to keep in mind that a very limited number of companies have been successfully increasing their dividend payment for 25 consecutive years. Those companies are called “dividend aristocrats”. There are 50 of them. A more elite group of companies exists where we consider only companies showing 50 consecutive years with a dividend increase. This small group of 18 companies are called the “dividend kings”. You can then imagine how you must remain cautious when you use a dividend growth rate as only 50 companies out of the S&P 500 had successfully increased their payouts long enough to be considered “an eternity of dividend payments”.

The tool I use to run my calculations is called the Dividend Toolkit. The toolkit comes with a 200 page book explaining how to find and assess strong dividend growth payers. This also comes with an excel spreadsheet doing all the hard work for you in order for you to avoid any miscalculation. The spreadsheet allows you to simply key-in the important numbers and it will run the dividend discount model for you without further error. There are two different dividend discount model spreadsheets. My favorite one is the double stage DDM. In this article, I will walk you through step-by-step in order to have the most precise valuation possible. There are four components in this spreadsheet:

Recent Annual Dividend Payment

Expected Dividend Growth Rate Years 1-10

Expected Terminal Dividend Growth Rate

Discount Rate

They are displayed as follows:

DDM explained 1

For the purpose of this example, we will take McCormick (MKC) figures as at July 2016. The idea is not to make MKC stock analysis but rather to take real numbers to show you how they work out in the dividend discount model. As the recent annual dividend payment is quite easy to find. MKC recently increased its payout to $0.43/share quarterly. We already have our first data to enter in the matrix:

DDM explained 2

Now, let’s focus on the dividend growth rate…

Dividend Growth Rate Years 1-10

The first dividend growth rate to enter in the DDM is your assumption of what is going to happen over the next 10 years. This number can be more optimistic as it will only affect a period of time for the calculation. Plus, it has a better chance to reflect the near future of a company. There are many ways you can determine this number. You can use the past 10 years dividend growth history, the past 5 years, 3 years or the most recent year. You can also use other metrics to enhance your analysis.

For example, MKC past 5 years dividend growth rate is at 9%. However, their most recent dividend increase was only of 7.5%. At the same time, the 5 years revenue growth was 5.18% and the 5 year EPS growth was 2.02%. Both recent revenue and EPS growth shows a 9% annual increase is unsustainable. Management seems to go towards the same assumptions as they raised their dividend by 7.5% in 2016. However, I can presume a sustainable dividend increase by looking at the payout (48.91%) and the cash payout (44.39%) ratios. Finally, MKC is spending 50% of its cash flow on business growth (introduction of new products, acquisitions and marketing). This means to me that MKC focuses on generating more revenues and eventually more cash flow for its shareholders. For this reason, I’ve selected a 7.50% dividend growth rate for the upcoming 10 years.

Here’s our second data to enter in our spreadsheet:

DDM explained 3

The terminal dividend growth rate is a little bit tricky though…

Terminal Dividend Growth Rate

The terminal rate is the one to be used “forever”. Already, the word “forever” is big enough, we now have to quantify it. A mistake in your assumption at this stage will render your calculations bogus. In this situation, it is important to give more thought about the company business model, its past history of dividend payments along with what is coming in the future. In other words, you can’t determine a stock valuation without doing its detailed analysis first. In order to save you some time, I’ve already done the McCormick stock analysis on Seeking Alpha. In the light of my analysis, I’ve determined that a 7% dividend growth rate was possible. I always tend to diminish the terminal dividend growth rate vs its first 10 years in order to be more conservative. Here’s what we have so far in our spreadsheet:

DDM explained 4

We are almost done (already!?!) before we get our valuation! All we need now is a discount rate.

Discount Rate

The discount rate reflects the risk vs return you expect from your investment. For example, if we had done the same analysis with treasury bills, the discount rate will have to be very small as it is a “risk free” return. When it comes down to investing in stocks, I use 4 differents discount rate.

9%: for companies with strong economic moat and stellar dividend growth history

10%: for companies with an economic advantage and a strong dividend growth history

11%: for companies showing additional risks (a weakness in their business model)

12%: for long shots

I don’t bother going too high or too low with the choice of my discount rate as it would not serve me well in the valuation process. For MKC, I will use a 9% discount rate based on the fact that MKC is a leader in its market, protects its model by investing massively in marketing and R&D and shows an impressive dividend payment record. In other words, this company shows less risks than Chevron (CVX) for example. We have then completed our spreadsheet:

DDM explained 5

Now… let’s see how much MKC worth if it was purely a dividend paying machine. But first, we must introduce one last concept. The margin of safety.

The Margin of Safety

As you probably realized by now, making these assumptions puts you right between science and magic when it comes down to determining the future of a company. As a small difference in your calculation would lead to completely different valuation, it is important to have a margin of safety. This margin is the room for error in your calculations. The Dividend Toolkit will not only give you the intrinsic value of the company you analyze based on your numbers, but it will also calculate various scenarios where the margin of safety goes from a 20% discount to a 20% premium. Here’s a complete example to show you how it works.

15 Possible Values with the Dividend Discount Model

We are now at the final stage of our calculations. Once you finish your input, you automatically see the result on the right side of the spreadsheet:

DDM explained 6

As you can see, the intrinsic value of MKC is $96.06. However, the Dividend Toolkit Spreadsheet also gives you the value if you had chose an 8% or a 10% discount rate. You also have various scenarios for its margin of safety. For example, if the stock would trade at $75 this morning and you have an intrinsic value of $96, you have a 20% discount value or 20% margin of safety. This means that you can buy the stock at $75 and even if you are wrong in your calculations, you still have 20% on the stock price as a margin of error. On the other hand, if the stock currently trades at $115, you know you are already paying an important premium. In other words, you have no room for error at this point.

As you can see, assigning a dollar value to a company is not that easy. You can get the Dividend Toolkit to help you in your investing process. Using this tool will enhance your investment process and give you a better indication as to when to buy the companies on your watch list and when to wait for a market correction.