“Things are not always as they seem; the first appearance deceives many.” – Phaedrus, Roman Poet
With historically low yields from GIC’s and bonds and a central bank led Zero Interest Rate Policy (ZIRP), income oriented investors have increasingly turned to dividend paying equities to deliver their income requirements. In the summer of 2012, I penned a three part series that focused on identifying dividend growers and cautioned against investing in companies with high current yields with poor dividend growth prospects. Just this week two widely followed high yielding US companies – Cliffs Resources and Centurylink – announced significant cuts to their dividends and investors responded by punishing them to the tune of a one day loss of -20% for Cliffs and -23% for Centurylink. In dividend income terms, it will take 4 to 5 years of dividend income to make up for the one day capital loss incurred CLF and CTL investors after these companies announced their dividend cuts. I can’t imagine this is what conservative income-oriented investors signed up for when they bought these former high yielding companies.
While the Cliffs dividend cut was not a surprise to me, the magnitude of the reduction of the dividend by 75% in addition to a large stock offering announced concurrently did catch Cliffs investors by surprise. Cliffs, due to the cyclical nature of their business, high payout ratio, stretched balance sheet and poor fundamentals for iron ore pricing, is not the type of dividend growth company we seek out for our conservative, income oriented clients. The Centurylink dividend cut was a significant shift in corporate philosophy as they cut the dividend by 25% and announced a $2 billion share buyback. For our income oriented investors, we consider Verizon and AT&T to be more appropriate dividend paying telecommunications stocks, both with long-term track record of dividend increases.
How might one avoid these types of dividend disasters? A good starting point is to ask yourself the following questions prior to investing in a company that pays above average dividends:
- What is the payout ratio relative to earnings and free cash flow?
- What is the value of the stock, regardless of the dividend yield.
- How much leverage is on the balance sheet?
- What do investors expect from the company?
Contrast these companies with US based consumer products company, Church and Dwight (Arm and Hammer, OxyClean) with a recently announced increase of 17% to their quarterly dividend. While Church and Dwight’s current yield of 1.86% doesn’t get your heart racing, over the last 3 years the company has doubled its quarterly dividend from $0.14 to $0.28 and the dividend has risen fourfold over the last 12 years. An investor who purchased CHD in late February 2010 at $33 would have a healthy yield on cost (current $1.12 dividend/$33 purchase price) of 3.39% but more importantly they would have enjoyed stock appreciation of 82.5% as the stock currently trades at $62.50! CHD is just one of many recent examples of quality companies to announce dividend increases. In our current US dividend income portfolio of 20 companies across multiple sectors, 17 companies increased their dividend in 2012 with an average increase in dividends of 11% over 2011. Certainly a good way to stay ahead of inflation if your are living on a fixed income.
Please feel free to contact us if you would like to learn more about investing for dividend growth or to review your current dividend income portfolio.
Investment research and information cited as of 02/22/2013
This information is not intended as nor does it constitute tax or legal advice. Readers should consult their own lawyer, accountant or other professional advisor when planning to implement a strategy. RBC Dominion Securities Inc. and its affiliates may have an investment banking or other relationship with some or all of the issuers mentioned herein and may trade in any of the securities mentioned herein either for their own account or the accounts of their customers. RBC Dominion Securities Inc. and its affiliates also may issue options on securities mentioned herein and may trade in options issued by others. Accordingly, RBC Dominion Securities Inc. or its affiliates may at any time have a long or short position in any such security or option thereon. Bill Holmes CIM, FMA, FCSI is an Investment Advisor with RBC Dominion Securities Inc. Member CIPF.