After The Dividend Cut: To Buy Or To Sell

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 |  Includes: AVY, CAG, F, GE, HOG, PLL, XEL
by: Jeff Paul

I previously analyzed a sample of consistent dividend growth stocks from 1999-2010 that cut their dividends, and observed a potential indicator that could warn investors in advance of the cut announcement. In the discussion, a question was asked about how the pre-2007 stocks performed after the cut, relative to the S&P. Did they recover, and how much? This article addresses these questions, and provides additional observations about this group of dividend-cutters, as well as more recent cutters.

I feel a couple of important qualifications are in order, given this particular group. The sample size of dividend-cutters is small, therefore the results don’t carry statistical weight. However, they are still rather interesting for discussion purposes. The sample consists of U.S. stocks, $500 million market cap minimum (mostly), non-financials, which increased dividends at least 7 consecutive years. (Basically non-micro cap, non-financials from the CCC lists.)

The discussion and results should be viewed to apply only to this subset of the dividend-paying stock universe, though perhaps they apply to other dividend-payers. I excluded financials because I didn’t have a list of yield-cutters from before 2008, and given the unusual magnitude of the 2008-2010 recession, I didn’t feel that it was necessarily representative of typical economic downturns. I did find an SA article by Clay King on this topic that included some financials, for those interested. Also, I split the cutters into pre- and post-2008 groups to analyze short/long-term recovery and to separate out the influence of the current crisis. On to the results.

1999-2006 Cutters

click to enlarge

The chart above contains the 1999-2006 dividend-cutters, their total return performance through 2007 and 2010, respectively, and the S&P’s (NYSEARCA:SPY) performance for the same time periods. I color-coded the stocks that totally eliminated their dividends (pink), reduced a dividend but have since halted it (purple), and reduced and have since raised their dividend (blue). The darker blue highlights are stocks that have regained a place on the Dividend Challengers list. Some interesting observations:

  • Most of the dividend-cutters continued paying dividends and eventually resumed raising them. 71% of the stocks had a positive total return by the end of 2007. The average dividend cut was around 60%.
  • Of the 5 stocks with negative total returns after six years, 4 of them were firms that totally eliminated dividends (either initially or at a second cut date).
  • As a group, the average total return through 2007 was an 89% gain since the cut announcement date, and 137% through 2010. This translates into approximate annualized gains of 11% and 10%, respectively. This handily beat the respective S&P returns of 41% (6% annualized) and 29% (3% annualized) for the same time periods. The S&P did not have any negative returns, however, and it did outperform ~30% of the yield-cutters.
  • The average total return of the seven stocks that regained CCC status is 182% by 2007 (19% annualized), and 269% (16% annualized) by 2010.

2008-2010 Cutters


The stocks in this group have not had as much time to recover, but I thought it would be interesting to see how they are doing and to compare this to the first group. The sample size of 16 was comparable to the 17 for the first group, but still too small for statistical purposes. The average cut date was around February 2009, so I used August 2011 as the end date for a rounded timeframe of 2.5 years. This group had a third category of stocks, those that reduced their dividend and have held it constant (yellow).

  • The average gain since the cut announcement was 51% (18% annualized) vs. 39% (14% annualized) for the S&P. Bear in mind that the S&P was impacted by the financials, while the sample group was not. However, the S&P still outperformed 44% of these stocks over the same time period.
  • The stocks that resumed dividend increases all had positive total returns by August 2011, averaging 106% (34% annualized). Assuming an investor owned the stock before the cut announcement, there’s a good chance s/he experienced a significant price decline ahead of the cut. For a 50% price decline, a 100% price gain is needed to just break even! From that perspective, this gain loses some punch; however, it did outperform the S&P (over 2x).
  • The two stocks that eliminated dividends did not have negative returns as in the first group; however, their individual returns were below the group average.
  • Performance of the stocks that have held the reduced dividend constant has varied. 5 of 8 are positive, while 3 of 8 are negative.

Analysis

The original question inquired about the long-term recovery of stocks that cut their dividend. I found it comforting to find that all but one of the dividend-cutters that reduced, but then raised, dividends had positive total returns over the respective time periods. Mileage varied, of course. Most were up 90%+ from their cut announcement date price, though it took up to six years to get there. I did not search for the earliest peak, so it is possible the gains were achieved much sooner. The entire sample beat the S&P, yielding 2x the return through 2007 and 4x the return through 2010. From a contrarian viewpoint, this strategy makes some sense: Buy the stocks that everyone else is getting rid of. If we could figure out which ones will resume consistent dividend increases and regain CCC status, we’d do even better based on this sample.

For the 2008-2010 group, the results were slightly different. The stocks that resumed dividend increases all had positive returns, and half already had triple-digit percentage gains in just 2.5 years on average. Unlike the first group, the two stocks that eliminated their dividends had positive returns. Those that reduced their dividend, but have not increased it, had mixed performance. This group beat the S&P, however, if we could back out financials from the S&P, I’m not so sure that claim would hold.

Potential Action Plans

Given the limited sample, I’m not sure any action plan is really valid, but here are some ideas for consideration.

  • If a stock completely eliminates its dividend, sell it. Based on the data, these stocks generally underperformed those that continued paying dividends, as well as the S&P. A dividend investor would do this anyway, as the income stream has been lost.
  • If the dividend is reduced, the typical response is to sell it, as the income stream is lowered and the stability of the firm may be in question. For those following a strict policy of investing in CCC stocks, the stock is a sell. However, if the stock’s price (value) has declined significantly since the investor purchased it, the new yield may not be that much lower than alternatives. It will depend on the size of the cut versus the decline in the price. Under this scenario, the data suggests that keeping the stock may be appropriate from a total return standpoint. A big question is whether the stock will resume dividend increases, and unfortunately, we can’t know that, though macro and fundamental analyses might offer educated guesses. There is definitely risk involved, and if less stress and more safety are desired, switching to another CCC stock is the better move. It is easier to trust a firm that continues to raise its dividend and hasn’t experienced major issues beyond the industry average, though we should keep watching for indicators of potential cuts in any stocks we own.
  • It would be interesting to examine the performance of alternative stocks in the same industry group to see the average impact of switching. As an example, American Greetings (NYSE:AM) fell a little over 50% from its pre-cut high, so the 96% gain in the chart above just gets the investor back to even. By comparison, other CCC consumer discretionary stocks had varying returns over the same time period: McDonald's (NYSE:MCD) was up 200%, Leggett & Platt (NYSE:LEG) was up 35%, and Meredith Corp (NYSE:MDP) was down 20%. Of course, without knowing how well AM’s management would solve the firm's problems, all else equal, AM was the riskiest of these stocks at that time.
  • For the more speculative dividend investor, buying these fallen dividend growth stocks could be a profitable strategy. With annualized gains over 10% in each sample group, those willing to tolerate some stress, and some losers, may end up with above market returns after a few years. Weeding out stocks that don’t raise their dividend could improve total returns, as well as firms with questionable fundamentals or macro-environment concerns.

Reflections

Personally, I am in the camp that would sell a DG stock that has cut its dividend. If my goal is to invest in consistent DG stocks, then a dividend-cutter no longer fits that requirement. The real value, which I started addressing in my previous articles, would come from finding indicators to help DG investors get out of these stocks before the cut announcement, to avoid both the income loss and the price decline. A good discussion was started, and hopefully it continues.

For the smaller portion of my portfolio that is more speculative and/or growth-oriented, I am intrigued by the results from this research, though I wish there was a larger sample to provide more confidence. For big-name, former DG firms, such as GE (NYSE:GE) or Harley Davidson (NYSE:HOG), buying on the cut announcement would have paid off handsomely. With fundamental research, I could be persuaded to buy these cutters, though it would be nice to know which will resume dividend increases, as those stocks really outperformed. Perhaps someone can devise a good post-cut indicator for this.

As a group, there were enough negative performers that I believe an investor following this strategy should be diversified (i.e. hold many dividend-cutters) to hopefully achieve an overall positive total return. With the economy slowly improving, the number of CCC cutters should decrease, so I’m not sure there will be enough in this sub-group of dividend payers to start following this strategy now, but I will be interested in tracking future dividend-cutters to see how they perform.

Dividend Cut Indicator References

For your reference, here are some articles and research papers that discuss potential indicators of dividend cuts.

SA Articles

Avoiding Dividend Cuts: Insights from the Number Crunchers

Dividends In Danger? Frontier, CenturyLink, Conoco Phillips, 3 Others Continue To Attract

Research Papers

Do Firms Manage Earnings to Meet Dividend Thresholds?

Adjusted Free Cash Flow and the Dividend Payout of the S&P 100

What Factors Motivate the Corporate Dividend Decision?

Sample Group of Dividend-Cutters, 1999-2006:

AM, F, MAT, MOD, SCI, IPG, CAG, RAD, SLE, KELYA, PLL, ROL, IFF, SCG, TE, WEC, XEL

Sample Group of Dividend-Cutters, 2008-2010:

DHI, HOG, LZB, MAR, NYT, GCI, BEAM, SVU, SUN, VLO, PFE, AVY, GE, MAS, VMC, CEG

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.