Are companies rushing their year-end dividend to avoid the fiscal cliff or is it just a last kiss goodbye to their payouts? For the first time in 20 months, funds invested in dividend ETFs are dropping. For the first time in many years, several companies are paying a special dividend before the end of the year.
I'm taking a quick pause from my utilities dividend growth stock series to talk about the possible impact of the fiscal cliff. I don't know if you have noticed this, but there are a lot of companies rushing their payout before the end of the year. In their announcement, they specifically mention that this exceptional ex-dividend date and dividend payout are prior to January 1st with the only goal of avoiding the possible new tax treatment on dividends in 2013.
Companies such as Oracle (ORCL), Cisco (CSCO), Seagate Technology (STX), Wal-Mart (WMT), etc. are paying their "regular" dividend in advance while other companies such as Wynn Resorts (WYNN) & Tyson Foods (TSN) are paying a special dividend before the fiscal cliff. At the same time, companies who refuse to get in line and pay their dividend prior to 2013 like GAP will be penalized by the market and see their shares plummet. Do companies and Wall Street Golden boys know something small investors don't? Are they planning on cutting their dividend after the fiscal cliff? Or is it the death of dividend growth?
Fiscal Cliff in Numbers
To answer these questions, we must understand what the fiscal cliff is. The fiscal cliff is a combination of measures that will drastically increase the Government revenues and cut its expenses. The revenue increases will come from the maturity of a series of special tax reductions that were enacted during the Bush Government. The expenses cut will come from a series of arrangements decided by congress in 2011 in order to decrease the debt level.
The problem is that the combination of both measures creates a "hole" in the economy equivalent to 3.7% of the USA GDP. So unless we see incredible economic growth in 2013, we are heading directly into another recession. Being in a recession is one thing, but what concerns folks the most is the tax increase detailed as follows:
The tax increase will mainly hit high income households along with capital gains and dividend payouts in general. I'm not a tax expert but I read that dividend income currently taxed at 15% could go as high as 38.6%. That's more than 20% less in your pocket for every dollar received in dividends!
How the Fiscal Cliff Influences Dividend Growth Stocks
We all know that the main goal of any CEO of any public company is to keep the share value as high as possible and to generate profits. If the share value is up, it's good for both investors and the CEO. We also know that several stocks attract investors with their dividend growth policy. For example, what has been the point of holding JNJ for the past 5 years (stock value is +3.13% but dividends increased by 45% during the same period) besides its ever growing dividend payout? None.
In a historically low rate environment, solid blue chips have slowly replaced a part of bonds and certificates of deposit in the fixed income portion of a portfolio. It seems like a good way to buy a stock that will be relatively stable over time while paying a dividend that is taxed less. What do you think would happen if the reason why you hold a stock is impacted by a tax increase of 23%? You might sell the shares and look elsewhere for another investment opportunity.
Stocks May Hold Off On Their Dividend Growth Strategy
We recently talked about a potential dividend bubble due to the fact that investors were rushing into dividend paying stocks to compensate for low interest bonds. The word quickly spread and several companies started to increase their dividends and adopted a dividend growth policy in order to get on the train and attract more investors. I'm not making this up, check out this chart showing the huge dividend burst that happened upon the dividend tax cut to 15%:
So maybe the fiscal cliff is not the end of the world and dividend investing is not dead. However, strong dividend growth stocks might be hard to find if several companies hold off on their dividend growth policy. Instead of increasing their dividend increases year after year, they might keep their money and use it for other projects.
We Are Not Done Yet With The Fiscal Cliff
Back in April, I discussed the pros and cons of Obama rising taxes on dividend. I'm obviously not a fan of the situation but it might not be as catastrophic as we think. There are still a lot of companies that will continue to pay dividends. On the other hand, nothing has been settled yet and the Government could still continue to debate throughout the beginning of 2013 as the taxes will be applied during the year but most likely paid in 2014.
So there is still hope that the dividend tax won't be hiked to 38% and that stocks will continue paying great dividends!
What's Your Take? Are You Afraid of the Fiscal Cliff?
Dividend investors prefer to receive cash right now instead of playing on a potential company growth. But if the dividend payout is taxed too much, there might be a loss of interest towards dividend investing.
Disclosure: I hold shares of JNJ & STX