In an era of unprecedented dividend cuts, money managers and financial advisers are stepping up their due diligence when searching for income.
In an era of unprecedented dividend cuts, money managers and financial advisers are stepping up their due diligence when searching for income.
“You have to be careful about looking for unusually high dividends, because the higher the yield, the bigger the risk that it will be cut,” said Donald Schreiber, founder and chief executive of Wealth Builders Inc., a Little Silver, N.J.-based firm with $300 million under management.
He advises looking for dividend-paying companies that don't have an imbalance of short-term debt coming due in the next 12 months which would exceed cash assets on the balance sheet.
“Look at cash flow from operations and short-term rolling debt,”Mr. Schreiber said. “Those things need to add up to positive or break-even.”
Like many dividend investors, Mr. Schreiber has had to adjust to a market where financial-sector stocks no longer represent the foundation of dividend income.
ON THE DEFENSIVE
“Right now, defensive stocks like pharmaceuticals, energy and a lot of utilities are screening best,” he said. “There are a plethora of companies paying dividends, but we're finding them all over the place.”
Financial stocks, which represented 30% of all dividends paid out by the companies making up the Standard & Poor's 500 stock index in December 2007, now represent just 9%.
Filling the void, however, are such sectors as consumer staples, energy, health care, industrials, information technology and telecommunications — all of which have seen their share of the benchmark's dividend payout increase over the past 17 months.
“We want companies that have the ability to continue to raise dividends, and all [Troubled Asset Relief Program]-taking banks are out,” said Henry Sanders, senior portfolio manager at River Road Asset Management LLC, a Louisville, Ky.-based firm with $2.7 billion under management.
“The overarching story is that the total universe of dividend-paying companies has shrunk,” he added.
Until recently, companies would go to extremes to avoid the stigma associated with a dividend cut. But as the economic downturn lingers, they are less reluctant to trim dividends to balance the books.
“One of the interesting things about this environment is that it has broadened enough that companies are now able to use the credit crisis for cover,” said Paul Larson, an analyst with Morningstar Inc. in Chicago.
“There seems to be some strength in numbers, so if a company was going to cut its dividend, now would be the time,” he added. “And if you do cut today you can just blame it on the environment.”
Dividend investment strategies traditionally associated with steady income streams have become less of a sure thing as companies continue to cut dividends in record numbers. Through May 25, dividends were cut or suspended by 63 of the companies making up the S&P 500. This compares with a record 62 companies in the index that cut or suspended dividends during all of 2008.
In 2007, just 12 companies in the index cut or suspended dividends.
“I've never seen anything like this, and I've been here 32 years,” said Howard Silverblatt, senior index analyst with Standard & Poor's Financial Services LLC, a unit of The McGraw-Hill Cos. in New York.
Many companies are holding — and some are even increasing — their dividends, but the payout levels are dropping in a dire sign of the times. Through May 25, 76 companies in the index increased their dividends by an average of 7%. This compares with 144 companies and an average of 13% in 2008 and 155 companies and an average of 17% in 2007.
“It's a very difficult time for dividend investing,” Mr. Silverblatt added. “And worst-hit is anyone on a fixed income.”
While the going has gotten a lot tougher, some dividend-investing specialists say careful research and precision can still produce solid dividend income for clients.
“If you're really interested in dividends, it makes sense to not just limit yourself to the universe that everybody else is using,” River Road Asset Management's Mr. Sanders said. “There are over five times as many companies in the small-cap space with dividends over 2% than there are in the large-cap space.”
At the end of March, Mr. Sanders counted 1,012 small-cap companies with dividend yields of at least 2%. The group's average-weighted dividend yield was 6.8%. This compares with 279 mid-cap companies with an average-weighted yield of 4.8% and 198 large-cap companies with an average-weighted yield of 4.7%.
Even with record-level dividend cuts, the flip side of lower stock prices is a higher dividend yield, which goes up when a stock price goes down.
RICH ENVIRONMENT
“The yield is up so much right now that even if you allow for all the cuts, this is the richest dividend environment we've seen in decades,” said Martin Jansen, senior portfolio manager with ING Investment Management in New York.
“There's an element of unpredictability that you have to factor in, but you can construct a portfolio today with a yield of more than 6%,” added Mr. Jansen, who is responsible for $6 billion worth of global dividend investments. He also stressed the importance of not chasing those paying the highest dividends.
“Like no other time in history, the range of possible outcomes is greater today, which is why it is important to find a balance of quality and sustainability,” Mr. Jansen said. “You want companies that are well-financed, with strong balance sheets and strong cash flow.”
The outlook for dividends gets better, Mr. Jansen said, as the economy improves and inflation kicks in.
“As we stabilize and start to head out of this great recession, dividends will stabilize and start growing again,” he said. “By 2011, with earnings recovering, dividends will start to grow and become an inflation hedge.”
E-mail Jeff Benjamin at jbenjamin@investmentnews.com.
