Dividend Cuts – What Would I Do

Increased dividend payouts are usually a sign of confidence in a company’s future and lead to a positive reaction in the stock price. But companies with a high level of debt and excessive dividend payouts are much more vulnerable to high inflation, interest rate hikes, and a slowdown in economic activity. Dividend cuts are often the result. And right now, we have such a special situation: interest rates are rising due to inflation, and companies are slashing earnings forecasts in the current earnings season. And therefore, the question comes up as to how to deal with dividend cuts or dividend cancellations.

Well, we know the dividend is just one of four ways a company can use its earnings. It can invest in its own expansion, e.g. in internal growth or in company acquisitions. It can pay off debt, it can buy back its own stocks, or can pay dividends. Young companies, like such from the quantum computing industry, rarely pay dividends because they want or need to grow fast. Mature companies are the typical dividend payers. They grow slowly and often do not know what to do with all their money.

As a rule, therefore, a dividend is paid out, which is often increased from year to year. But just as earnings don’t grow linearly every year, the dividend doesn’t have to keep growing annually either. When asked what they would do about dividend cuts and cancellations, many investors answer that they would sell the stock immediately.

Treat Dividend Cuts With Differentiation

But is this really necessary, or should one look at the whole thing in a more differentiated way? For example, we have the COVID-19 crisis behind us. And for the first time in many years, we have seen drastic and rapid interest rate increases that are not over yet. We also are seeing the risk of a possible recession.

That’s why I ask questions like: If the company is cutting the dividend, why is it doing it? And is there any chance that the dividend will come back to me as soon as possible?

For example, in 2020, many companies had their dividends cut or suspended them. However, anyone who has held REITs has done nothing wrong. Because here, due to legal requirements, it was foreseeable that the dividend would be paid again.

With the paper manufacturer Domtar, on the other hand, an investor could be very consistent. For this company suspended its dividend, and today it is no longer public.

Dividend cuts were also predicted at other companies, such as Hotel Chatham Lodging Trust, which could have been sold immediately. This monthly payer had announced that they want to link the dividend payment more closely to the company’s results in the future. And that was a warning shot that you had to interpret correctly.

To give you an example where you shouldn’t have sold was at Foot Locker. Because even though Foot Locker suspended its dividend in 2020, it’s higher today than in 2020.

The difference is, quite simply, that if a company cuts its dividend for growth or development projects and has a plausible reason for doing so, it should get a bonus.

An example of such a situation is the shipping container rental company Triton. Triton cut its dividend in the summer of 2016 to fund its merger with TAL International. In this case, it was worth holding the shares because the merger had created a market leader. This market leader paying today a decent dividend of around 4%

Companies like PetMed Express or the much-scolded Intel can also be classified in the same category. Intel, for example, announced in February 2023 that it would cut its dividend. But at this point, investors should simply give the boards the freedom to implement their restructuring and investment plans. First, it takes time, and second, it takes money. And this money may then be missing for two or three years for the dividend. So if the money gets used to finance growth, you can reluctantly accept it today and keep the share.

At Hanesbrands, for example, you can proceed differently. This company wants to focus on cleaning up its balance sheet, so it has suspended its dividend. That’s why an investor can get rid of stock without regret, even if the company has kept the dividend constant during the COVID-19 crisis.

Back at that time, we were still living in a low-interest-rate environment. In 2023 the company is now confronted with the fact that a refinancing round for the high level of debt is due in the coming year. At the same time, money is getting a little tight. That’s why Hanesbrands, for example, separated from the European business in order to make a little money here.

On the other hand, the company is very attached to one product line with the Champion brand, and after all, the underwear market is not necessarily a booming market segment.

The banks will, therefore, take a close look at the follow-up financing conditions at which they give the company new loans. And it may be that one of the conditions is that the company is not allowed to pay out dividends.

Therefore, a large part of the saved dividends at Hanesbrands will probably have to be used to pay off debt and build up cash reserves for follow-up financing. Hence, there can be no question of growth at all, but of maintaining business operations.

Final Words

Investors should take a more differentiated look at dividend cuts and, like a business owner, question the purpose of the dividend cut. If the money is invested in future-oriented growth, the company should get a bonus. For in the medium term, the invested capital should yield higher returns.

However, if the company needs the money to correct past mistakes, then an investor should be much more skeptical. You can’t blame the company for that. Because the fault probably lies with the investor and not with the firm. Investing in companies with high debts always involves high risks. If you take better care of your money from the start by analyzing the company thoroughly, you won’t have to worry about the reduced dividends afterward.

About the Author

This is a guest post from Max over at Snoppy Alien who has a passion for photography, travel, and Investing.

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