Dividend investing in a volatile market

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U.S. companies are cutting or suspending dividends at a rate not seen since the global financial crisis. But investors should remain focused on the longer term performance.

Dividends have historically been an important component of equity total return. In the beginning of 2020, we believed their contribution would rise relative to equity price returns, which we expected to be lower.



But now, given the pressures of the pandemic-related economic slowdown, companies looking for ways to conserve cashflow are targeting dividend payments. The number of companies that have announced a cut and/or suspension of dividends is now at its highest level since the global financial crisis (GFC).


While the comparison to the GFC may make for a good headline, there are important distinctions to bear in mind. Most important is that, unlike the crisis of 2008, which was largely focused on one sector of the economy, the economic shutdown implemented to contain the virus is impacting almost all businesses. Many companies that were otherwise assumed to be strong have had to reassess their financial strategies. The impact is particularly severe for industries such as travel and leisure, but by virtue of the pervasiveness of the shutdown, it’s not surprising to see a higher number of announced cuts and suspensions.


What to expect going forward

We expect to see further dividend cuts or suspension announcements during the upcoming earnings season. In particular, companies with higher leverage, or those that have been funding their dividends through means other than high free cash flow, may be more likely to announce cuts or suspensions.


While some companies use their dividend policy to reward investors for participating in their company’s growth, others use their policy to support the stock price because their earnings growth is insufficient. It’s these latter companies (outside of those more directly impacted by the slowdown) that are now under greater pressure to cut or suspend dividends as a way to conserve cash. In certain cases, companies accepting federal aid (in the form of grants or loans) as part of the CARES Act will have no choice but to cut or suspend their dividend — programs have made “no payouts or buybacks” a condition of receiving aid.


Dividend cut levels will likely approach and may exceed the GFC era, led by cuts in energy and certain consumer areas. The big U.S. banks, the epicenter of the 2008-2009 market crisis, have entered this crisis in a strong capital position — well in excess of the Fed’s regulatory capital minimums. We don’t expect a raft of cuts here, but will continue to watch this sector closely.


Keep performance in perspective

We believe that it’s critical for investors to remain focused on the longer term performance of dividend stocks. Over the long term, companies that grow and initiate dividends have outperformed the S&P 500 Index annual average gain of 6.9%.2 And looking at the last three recessions, dividend initiators and growers in the S&P 500 were able to outperform non-dividend stocks, as well as the index overall. 3



Bottom line: What works for dividend investors

This is an unusual environment. Even healthy companies are being pressured to cut or suspend dividend payments. Intense research is critical to uncovering opportunities for long-term investors. This means focusing on companies with high free cash flows (normalized) and healthy balance sheets. These companies may be more likely to successfully weather a recession without having to cut dividend payments. As always, we advise against chasing the highest yielding stocks. Yield for the sake of yield is typically not a sound investment strategy — stocks that are higher yielding, but without underlying earnings growth to support the dividend, may be more likely to see a cut or suspension.


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