When GE announced last Monday it was cutting its dividend in half, investors were reminded that the search for yield is complicated and more risky than they might have believed.
Before the dividend cut, GE was paying out 24 cents a share per month, but its earnings were declining along with cash flow, leading several analysts to downgrade their outlooks. Its long-time CEO Jeff Immelt had already announced his upcoming retirement and subsequently announced his departure from the board of directors – where he was chairman – earlier than expected. Meantime, the stock's dividend yield kept climbing, to more than 5%, as its stock price continued to fall.
"Just going with large established businesses these days is not good enough," says John Gomez, president of Santa Barbara Asset Management.
Investors interested in dividend-paying stocks need to distinguish between companies that pay high dividends and companies that grow their dividends, says Jeff Chang, the chief operating officer of CBOE Vest.
Consistent dividend growth is a better indicator of a company's financial strength than high payouts, and dividend growers tend to outperform dividend high payers over time, Chang says.
Free cash flow, the amount of operating cash flow minus capital expenses, is key to assessing a company's ability to maintain and grow its dividend. Does it have enough free cash flow to support its dividend, and a possible dividend increase?
