G.E. cut reminds us to do our homework

Last month, General Electric (NYSE: GE) CEO Jeffrey Immelt seemed to be favoring maintaining the firm’s dividend over its solid AAA credit rating. But he recently announced that the company would cut its dividend by two-thirds, from 31 cents to 10 cents per share.

The cut had already been expected by many investors. Even at 10 cents, the annual dividend yield is around 4 percent, about 1 point above the 10-year Treasury yield.

The cut will produce cash savings of about $9 billion annually, reassuring the credit rating agencies that monitor (and recently downgraded) GE.

Immelt is eating a little crow now, but he’s at a crowded banquet. The list of companies that have cut their dividends recently reads like a who’s who of corporate America (admittedly, many of them are financials), including Bank of America, Dow Chemical and Motorola.

The lesson here is that CEOs are having as much difficulty wrapping their heads around the magnitude of the current crisis as anyone else. Investors can’t rely on executives’ reassurances that a company will maintain its dividend, as these may not be based on an objective assessment of economic fundamentals. However, the numbers don’t lie: Dividend-oriented investors must be extra diligent in analyzing a firm’s financial position and earnings power through the downturn. It’s the only way to avoid being faked out by an overly optimistic CEO.

Ask the Fool

Q: Who sets stock prices? – J.G., Elkhart, Ind.

A: A company’s stock price isn’t set by anyone. Rather, once shares have been sold by the company to the public (either via an initial public offering or a secondary offering), they trade fairly freely in the stock market.

Think of the collectible comic book market. A comic book’s value is what people will pay for it. If demand rises or falls, so does the price. That’s why, if there’s bad news about a company, its stock will usually soon be worth less and vice versa.

Q: What’s “market share”? – E.K., Farmington, N.M.

A: The useful online glossary at investorwords.com provides a good definition: “The percentage of the total sales of a given type of product or service that are attributable to a given company.”

Consider the world of cell phones. According to ABI Research’s data for 2008 worldwide, Nokia leads the market with 38.6 percent of phones. Its share is more than double that of its nearest competitor, Samsung, with its share of 16.2 percent. Next are Motorola and LG Electronics, each with 8.3 percent, and Sony Ericsson, at 8 percent. Research in Motion is far behind, at 1.9 percent, followed by Apple, which topped 1 percent.

That might look bad for Apple, but remember – it’s important to look at growth rates, too. Apple’s market share is up a whopping 267 percent over last year. If it keeps growing at even half that rate for a few years, it can quickly catch up.

My dumbest investment

I’ll take responsibility for this. But now that I know better, I’ll never listen to another broker without evaluating the suggestion for myself. Years ago, I bought Nortel Networks at my broker’s recommendation around $60. He finally contacted me when it was at $6 to ask if I wanted to sell. (It recently filed for Chapter 11 bankruptcy.) About a year ago, I bought Terex for around $105 – once again, on a broker’s recommendation. I ended up losing about 80 percent of my investment. More recently, I bought Citigroup at $22 – yes, on the recommendation of my broker. This is when I began to get smart. If I’d waited to hear from him to sell, I’d probably be holding it today. I did my own research and sold at $24 for a decent gain. That’s when I decided I didn’t need a broker anymore. – Dave Kaczmarek, Los Angeles

The Fool responds: Some brokers are good and will serve you well, while others are more interested in getting you to buy or sell something, which generates commissions for them.