How to Dodge the Dividend Cut

Where is the Yield? submits: Investors who own Chiquita Brands International Inc. (CQB), Ford Motor Co. (F) or Pier 1 Imports Inc. (PIR) recently learned the hard way that regular dividends are not guaranteed to grow, or indeed to even be maintained at their current levels. When companies get into cash trouble, your dividends are in grave danger. When that happens, you want to bail before the news about the dividend cut hit the wires.

The dividend cut is the proverbial other shoe, and its drop can almost always be anticipated. One key indicator investors should always look at is credit rating. A company that borrows money at junk rates, only to pay some of it to shareholders, is not likely to keep this losing practice up for long. Apart from the credit rating itself, you should always watch the trend: A company that is getting downgraded by the Moody's and Fitches of this world, or even gets placed on negative outlook, is usually heading in the wrong direction.

Another number you have to watch is the company's cash flow from operations. If the business is not generating cash, eventually there would be none to be paid to shareholders. It really is that simple.

Finally, you should consider the company's long-term dividend track record. If it has a multi-year record of consistently paying never-decreasing dividends, that is a good sign. That's what lists like the "Dividend Achievers" and the "Dividend Aristocrats" are all about.

It's important to note that none of these factors is a silver bullet. There is no one single silver bullet. But the combination of the three fails rarely. Chiquita Brands had a very good record of paying dividends and respectable cash flow generation. But the junky credit rating was the red flag. They just had too much debt, and therefore were vulnerable to the shocks that hit them. The same can certainly be said about Ford. Dividend investors should have bailed back when the credit rating started its long slide into junkdom.

With Pier 1 it was even easier: They had negative cash flow from operations in their last annual report and 2 out of the last 4 reported quarters.

If you're going to own individual dividend paying stocks (as opposed to, and probably in addition to dividend ETFs), you have to make sure the companies you own have a good record, good credit rating and credit rating momentum, and are generating lots of cash from operations. A change for the worse in any one of these indicators, is usually a sign the stock is not worth the risk.

Comment on this article