(Not) Paying Dividends

April 16, 2020

Source: ICE Data Services Source: ICE Data Services

Over the long term, dividend-paying stocks have traditionally played a stabilizing and return-additive role in an investor’s portfolio. Reinvesting these dividends back into the underlying stock has produced far better returns than most major indexes without reinvested dividends. Years ago, dividend producers were thought to be safer and less volatile than their growth stock counterparts. Slow but steady businesses historically have not required significant reinvestment, so excess cash flow was returned to shareholders as a dividend. However, in the market’s recent downturn, dividend stocks have not been safer or less volatile. Dividend payers (and other value stocks) have performed worse than high growth, momentum stocks — a surprisingly different result than the downturn in 2000, for example. In fact, as shown in this week’s chart, hundreds of corporations globally were forced to cancel their dividend payments in March.

What has contributed to the underperformance of value stocks and the high number of dividend cancellations? One reason is that the economy was forced to shut down in order to contain the spread of the coronavirus with business activity grinding to a halt. Many companies’ sales, earnings and cash flow declined as well. As earnings estimates were cut and/or eliminated, (estimated) dividend payout ratios soared. With significantly reduced cash flow and expected dividend payments ahead, most companies that did not have the balance sheet flexibility to withstand this (hopefully) short-term decline in business were forced to cut, suspend or eliminate their dividends. Globally, this led to a staggering number of cancellations in March and, unfortunately, holders of dividend-paying stocks paid the price.

Key Takeaway

The number of dividend cuts will likely continue to increase in the near term as companies assess the recent economic impact of the coronavirus pandemic on their businesses. This should keep dividend stock investors on their toes. However, there is a way for investors to combat the recent trend in dividend reductions, suspensions and eliminations. Focusing on companies with high-quality balance sheets — little to no debt relative to cash and sustainable free cash-flow generation — can provide an important buffer whenever the economy declines. This financial flexibility typically leads to maintainable dividends or at least the avoidance of dividend eliminations. Prudent management teams with a track record of responsible capital allocation will give their companies and shareholders a solid footing to help weather any storm.

Tags: Coronavirus | dividend cuts | dividend-paying stocks | Earnings

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