Aside from being the classic fairy tale fatalist, Chicken Little would’ve made for the crack financial analyst, at least in answering this question: When dividends are falling, is the sky falling, too?
The question bears weight — enough to crush an investor’s portfolio — because a plummeting dividend could signify big trouble. Of course, much depends on how far the dividend drops, and how fast. Arguably, a dip may not mean all that much. Few companies have upped their dividends without interruption in consecutive years without a hiccup or plateau. In fact, the roll call of dividend aristocrats is short. It’s not easy to raise payouts for 25 straight years or more.
The list, if you’re wondering, includes both Coca-Cola Co. (ticker: KO) and PepsiCo ( PEP), coming in at 55 and 45 years respectively. Maybe that’s one way to score the Coke-Pepsi rivalry. But both lag behind the current champ, American States Water Co. ( AWR) at 63 years: a dividend king of nearly senior citizen proportions.
[See: 7 of the Best Dividend Stocks to Buy for 2018.]
But sometimes, a single drop can set off panic in the pit. In the case of General Electric Co. ( GE) and its December dividend, investors couldn’t have dreaded a bigger lump of coal in their stockings. It wasn’t just trimmed but slashed in half: from 24 to 12 cents per share quarterly. It was only the second time since the Great Depression GE had cut its payout — and the last was during the recession in 2009.
What has GE done since? The math is all too easy and queasy to do. During the week it was announced in November 2017, GE’s stock price took a 12 percent hit. As of June 2018, the belly flop has shaved close to a third off GE’s share price, now less than $14. Longer term, it’s been nothing but snake eyes since January 2017, with GE off 54 percent overall.
“The absolute last thing that a company wants to do is to cut its dividend,” says Robert Johnson, principal at the Fed Policy Investment Research Group, in Charlottesville, Virginia. “It is the strongest signal the company could possibly send that it is in financial trouble.”
And yet, what does it mean if a company makes that choice more thoughtfully? In some cases, it could signify a strategic shift aimed at generating rewards for shareholders.
“Theoretically speaking, a reduction in dividends by itself does not change the return of an investment,” says Joshua Escalante Troesh, founder, Purposeful Strategic Partners and a professor of business at El Camino College in Torrance, California.
“Earnings not paid out in dividends are retained by the company to help it grow,” he says. “This should increase the value of the company, which would be reflected in the stock price.”
So when the right occasion presents itself, less may mean more.
“If the company has a significant business opportunity and believes they can invest for a higher return, reducing the dividend so the company can make the investments could be a great benefit for the investor,” Troesch says.
[See: 9 Dividend Aristocrats for Stable Income.]
That said, cash flow problems or low profitability represent opposing factors for lower dividends. It’s not hard to discern which thrust, a positive or negative one, explains reversed dividend momentum. The trick is to separate corporate spin from tailspin.
For example, CEO John Flannery had this to say when General Electric lopped the head off its dividend: “We are focused on driving total shareholder return and believe this is the right decision to align our dividend payout to cash flow.”
Given that kind of verbiage, you might want to rethink cutting an apple in half as “aligning” it.
“If you’re asking about dividends actually being cut or eliminated by a company, then red flag it, to put it mildly,” says Ryan Krueger of Krueger & Catalano Capital Partners in Houston. “I don’t walk to exit: I run.”
Krueger points to a nuanced piece of the puzzle, one that concerns a falling dividend yield. “It’s on a lot of investors’ minds now, spiked by fears that risk-free bond rates are catching up or even passing many of those at-risk dividend yields,” he says.
By contrast, if dividend yields go up, starting in the low 2 percent range, investors could be looking at quite the nest egg over the decades by the time they reach retirement age, provided a stock’s price remains steady or appreciates.
Like the basketball fan he is, Krueger refers to this as the “Mikan rule” after Minneapolis Lakers great George Mikan, who led his team to five consecutive championships by hitting two-point shots from point-blank range. If you look at dividend aristocrats, their payments have jumped more than 9 percent a year: not so much a slam dunk as an easy layup.
Of course, you could travel back in time to the era of Chicken Little, or close to it. In 1976, a groundbreaking American economist named Fischer Sheffey Black contended that dividends were in essence an illusion. “The harder we look at the dividend picture,” he wrote in the Journal of Portfolio Management, “the more it seems like a puzzle, with pieces that just don’t fit together.”
[See: 8 Dividend ETFs That Pay You More.]
Then again, if you’ve ridden a wave of dividend increases in the years since to a small fortune, you may beg to differ. Clear blue skies do not fall down.
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How Investors Should Read a Dividend Cut originally appeared on usnews.com
