Shareholders of General Electric Co. (GE) , especially those who are retired and are (or were) relying on the stock's 24-cent quarterly dividend to fund their living expenses, should not panic -- even though the stock is down a good deal this month.
But they might want to revisit their rationale for owning GE, which has a current yield of 4.5%.
John Flannery, the CEO of GE, announced plans to restructure the company and focus on healthcare, aviation and energy, and halve its quarterly dividend to 12 cents a share.
Joseph Clemens, the co-founder and owner of Wisdom Wealth Strategies, as well as an instructor for the College for Financial Planning, said investors should now ask themselves the following question: "Is GE's current expected return, factoring in price and income potential, better than other similar investments I can find right now?"
Clemens' answer to that question leans toward no.
Time to Evaluate Alternatives
Other financial planners, meanwhile, say investors have some choices to make based on their unique situations and circumstances.
"Investors liked GE because it was a stable company with a consistent rising dividend," said Peter Snow, director of investment research with NFP Corporate Benefits. "GE no longer has that profile."
However, GE has now become a turnaround story and Flannery has his work cut out for him with an aggressive agenda, Snow said. "If income investors want to stay in this position, they may need to be patient before they see favorable results, particularly regarding a dividend increase," he said.
Patience may also mean not bailing on GE just because the stock has declined dramatically in value this week. "I hate seeing investors sell a position after it has lost substantial value, as GE has," said Snow. "The best time to buy a stock -- and the worst time to sell -- is after the price has pulled back."
Snow noted, for instance, that younger, longer-term investors may have the luxury to hold on to GE shares for the next 5 or 10 years.
As a retiree counting on the income, however, it may be time to evaluate attractive alternatives. (Some of those alternatives, for those looking for high returns but avoid the risk of owning a single stock, include ProShares S&P 500 Aristocrats (NOBL) , Vanguard FTSE All-World ex-US ETF (VEU) , and iShares MSCI Emerging Markets ETF (IEMG) )
Over on Real Money, Jim Cramer says General Electric really owes us an explanation now. Get more on his insights with a free trial subscription to Real Money.
If GE represents a small allocation in your broad portfolio, Snow said it may be time to cut your losses and find a suitable replacement. "There are many sectors that have stocks trading attractive valuations," he said. "Energy is a great example of a sector that has broadly pulled back, as has communications."
However, if you dig, Snow said, you can find great companies at attractive valuations in almost every sector. "I would encourage investors to look for companies with a long history of paying dividends. "Once a company starts paying dividends, management is reluctant to cut it, which is why GE is such big news," said Snow. (Check out Vanguard Dividend Appreciation ETF (VIG) , which seeks to track the performance of the Dividend Achievers Select Index.)
In addition, Snow said he likes to look for consistent (and growing) free cash flows. "It is tempting to look at earnings per share or net income, but neither are good proxies for cash flows as they both can be manipulated through different accounting methods," said Snow. (Two examples that might fit the bill include Pacer US Cash Cows 100 ETF and Pacer Global Cash Cows Dividend ETF.)
Lastly, Snow suggested looking for companies that have a reasonable payout ratio. "If a company is using too much of its free cash to pay a dividend, as is the current case for GE, that leaves little cash for investing in future growth," he said. (One example: Dow Jones Global Select Dividend Index Fund.)
If GE represents a larger portion of a portfolio, perhaps for a long-time employee that accumulated stock through the years, Snow said the plan of action is not as clear. "Investors are no doubt frustrated because their income was cut in half," he said. "Making matters worse, the stock has lost 40% of its value over the course of 2017."
Replacing the lost income may be difficult, but not impossible, said Snow. "If an investor wanted to exchange their position in GE for stock in another company, that is dollar for dollar, they would need to find a stock with a current yield of 5.39% -- over twice GE's expected yield -- to fully replace the income they received from GE over the trailing 12 months," he said. "There are quality companies out there that have a yield over 5% if you are willing to roll up your sleeves and look."
Another area for investors to consider is preferred stock, said Snow. "Preferred stocks usually have a higher yield than the common stock or bonds of a company, and are less volatile than the common shares due to their position in the capital structure," he said.
For instance, two of the largest preferred stock exchange-traded funds (measured by assets) currently have a 5.75% (iShares U.S. Preferred Stock ETF (PFF) ) and a 5.66% (PowerShares Preferred Portfolio (PGX) ) yield.
And although it doesn't necessarily help the current situation, Snow said he'd encourage shareholders to focus not so much on GE's current yield of about 2.5%, but what he would call the basis yield: current dividend payments divided by what you paid for the stock. "For long-time shareholders, the basis yield may be much higher than the current yield," he said. "Although it doesn't change the situation, it may take the sting out of it knowing you have done well through the years."
Lastly, Snow said, a lesson learned from those who had a large position in GE: "A prudent strategy is to diversify your investments," he said. "Any position worth more than 5% of your portfolio would be considered concentrated, and you could reduce risk by adding additional investments in diverse sectors."
A good rule of thumb that he follows with his clients is that no position should represent a higher allocation than what you receive in the form of income from your portfolio. "If your portfolio is yielding 4%, you wouldn't want one stock to represent more than 4% of your portfolio," Snow said. "Following this strategy means that if something happens to the dividend of a company -- a dividend cut or an acquisition -- it won't have a devastating impact on your cash flow."
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