The onset and spread of COVID-19 have brought about unprecedented impacts on our lives and the financial markets. Monetary response from the Fed to help address the crisis came first, and Congress recently passed over $2 trillion in fiscal measures. Here, we highlight three important questions for dividend investors to consider.
Potentially, yes. One of the components of the CARES Act stimulus bill is a lending program in which the Treasury Department can provide businesses up to $500 billion in loans, guarantees, and investments. The program includes restrictions on the companies that choose to participate. Companies receiving federal assistance will, among other restrictions, be prohibited from paying a dividend for a period of time. This means that investors who rely on their equity portfolios to produce income may face a reduction in their dividends.
Not all dividend-paying stocks are created equal. Generally, there are two broad categories of dividend paying stocks—dividend growers, and high dividend yielders. Historically, high-quality companies that have continuously grown their dividends have displayed durable business models, stable earnings, solid fundamentals, and strong histories of profit and growth. And as a result, strategies featuring dividend growth companies have exhibited strong performance characteristics under a wide range of market conditions. Conversely, there are the companies that pay high dividend yields that often appeal to income-seeking investors. Many lesser-quality stocks tend to use greater portions of their earnings and cash flows to pay their dividends. This means they oftentimes have less financial flexibility when their underlying businesses suffer.
Regardless of which companies ultimately accept assistance from the stimulus bill, many analysts expect a wave of companies to cut, suspend, or eliminate their dividends simply as a means of preserving liquidity. Of course, there’s no way to predict for certain which companies will accept the stimulus package, or to know what companies may adapt their dividend policies for other reasons. However, it may potentially serve as an indicator that certain companies have grown their dividends during previous downturns; there may be precedent of their willingness and ability to grow their dividends again, despite challenging markets. It remains to be seen if other companies, such as those with only a short history of paying dividends or those with particularly high yields, prioritize sustaining dividends in these environments.
While much remains uncertain, the highest-quality companies have, however, proven their ability to grow their dividends over time. And they have demonstrated an ability to survive through a range of market environments, even raising dividends after previous recessions. Let’s take, for example, the S&P 500 Dividend Aristocrats—an elite group of companies that have grown their dividends for at least 25 consecutive years. The most recent annual dividends paid by S&P 500 Dividend Aristocrats companies were, on average, approximately 46% of their free cash flows. This means that Aristocrats’ dividends were well covered, as their dividends amounted to slightly less than half of their available cash flows. By contrast, there are approximately 150 members of the broader S&P 500 with either negative free cash-flow payout ratios or payout ratios that are higher than those of the Aristocrats.
Looking back on other historic drawdowns, companies with the longest historical track records of dividend growth have tended to lose less as the market goes down and outperform when the market rebounds. While we’re certainly in unprecedented times, in these cases, dividend growth strategies demonstrated their worth for investors’ portfolios. Could they be positioned to do so again?
Source for data and statistics: Bloomberg, FactSet
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