Dividend Cuts and Other Unnatural Acts
The dividend is considered sacrosanct among income investors. A cut to the payout is viewed as an unnatural act, on a par with opening the Ark of the Covenant or selling your soul to the devil.
That’s why the coronavirus has been so traumatic for investors who emphasize dividend payers. However, evidence suggests that the worst is over.
According to a report released May 26 by research firm Janus Henderson, dividend payments globally are projected to increase 7.3% in 2021 on a year-over-year basis. Globally, just one company in five (18%) cut its dividend year-over-year in Q1 2021, far below the one third (34%) over the last year overall.
Indeed, as the economic recovery accelerates, dividends are growing again. The median dividend increase among U.S. companies was 4% in the first quarter. The brighter future for dividends is lifting the stock market as a whole.
U.S. stocks mostly rose Thursday, on better-than-expected jobs and economic data. The Dow Jones Industrial Average climbed 141.59 points (+0.41%) and the S&P 500 rose 4.89 points (+0.12%), but the tech-intensive NASDAQ slipped 1.72 points (-0.01%). In pre-market futures contracts Friday, the three indices were trading higher as optimism over the economy grows.
The pandemic-induced plunge in payouts…
Global dividends plunged in 2020 because of the COVID-19 outbreak, with dividends falling 12.2% in 2020 to $1.26 trillion. Dividend cuts totaled $220 billion between the second and fourth quarters of 2020.
Notably, in a move that shocked the investment world, energy supermajor Royal Dutch Shell (NYSE: RDS.A, RDS.B) announced in April 2020 that it would slash its payout by two-thirds, the first cut to its dividend since 1945 (see chart).
Many beleaguered companies such as Shell decided they had no choice. A dividend cut improves a company’s cash outflows and boosts both the retained earnings and cash account balances.
Sure enough, Shell raised its dividend in April 2021 for the second time in six months, as profits surged amid the energy sector’s rebound.
By value, Wells Fargo (NYSE: WFC), Boeing (NYSE: BA), Walt Disney (NYSE: DIS), Occidental Petroleum (NYSE: OXY), and Marriott International (NSDQ: MAR) accounted for about half of the U.S. cuts in Q1.
Companies that reduce or eliminate their dividend payments aren’t necessarily on the road to bankruptcy. But a dividend cut can be an ominous portent.
If a company you own has slashed its payout, watch for falling or volatile profitability. Beware of an excessively high dividend yield compared to peers. Negative free cash flow is another bad sign.
When investing in dividend-paying stocks, investors need to be mindful of the trade-off between risk and reward. If a company suddenly can’t generate enough cash flow to support its dividend, it may cut the dividend or get rid of it altogether.
When judging the merits of a dividend stock, always look for 1) healthy payout ratios; 2) plenty of cash on hand; and 3) earnings growth. These quality dividend payers demonstrate greater resilience during an environment of rising rates and market volatility.
Wall Street tends to harshly punish companies that cut their dividend. Telecom giant AT&T (NYSE: T) lost more than $30 billion in market value last week after it buried plans for a dividend cut within the fine print of its divestiture plans. The company, for decades a dividend stalwart, will cut its dividend nearly in half and relinquish its title as a Dividend Aristocrat.
AT&T announced May 17 it will spin off its media division WarnerMedia and merge it with Discovery (NSDQ: DISCA). AT&T plans to use proceeds to pay down its massive debt of more than $160 billion. Once it becomes a pure-play telecom again, AT&T will be in fitter, leaner shape to implement its 5G (fifth generation) wireless network. But to free up cash, the company also is cutting the dividend.
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John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com. To subscribe to his video channel, follow this link.