Dividend Streaks - Do They Really Matter?

Includes: DVY, GE, SDY, VIG
by: Counterpoint

I never missed a day of school from 1st through 12th grade. I remember once being sick and going to the doctor who delivered the news that he thought every kid wanted to hear ... "looks like you'll have to take a few days off from school." Not me ... I remember bursting out in tears (I'm hoping I was only in 1st or 2nd grade to have such a reaction) and insisting I would do no such thing. At the end of every school year, there was special recognition given to those that had perfect attendance and I had to be on that list. As the years passed, I was even more determined not to miss a day so as not to break "the streak". Of course I was lucky I never had a serious illness or the streak would have ended. So first, to my secondary school friends, my apologies if I ever made any of you sick.

So what is the relevance of this to dividend investing? For most dividend growth investors, an historic record of consecutive years paying increasing dividends is one of the main screens used to determine which stocks to invest in. This may well be the single most frequently cited metric in comments by dividend growth investors on Seeking Alpha. In a sense this is a very positive thing because it shows that a primary concern of most (and, in my opinion, the smartest) dividend growth investors is not simply to seek out the highest current yield, but to patiently build a portfolio of stocks that will provide a reliable and growing stream of income for years to come. But it goes beyond individual investors. There are also some mutual funds and ETFs that use dividend increase longevity as one of their primary investment criteria (SDY, DVY, VIG for example - I am long SDY ).

I searched for a study thinking that, given the institutional use of this metric, there must be some clear data somewhere that serves as the mathematical basis for its link with dividend sustainability. A couple of articles pointed to the price performance of stocks with long dividend increase histories noting a slight outperformance and lower beta as compared to the S&P 500. Perhaps this is the reason that these funds use this as part of their investment criteria, but it does not speak to dividend sustainability.

Most other articles noted two qualitative reasons as to why longevity should be considered as a measure of the likelihood of a dividend cut. One is that the longer the streak of paying increasing dividends, the deeper the moral commitment is to its continuance (much like my secondary school attendance streak). The second is that a longer streak is evidence that a company can weather a wide variety of business cycles and still continue to provide steadily and increasing cash returns to its shareholders. While indeed these may be valid reasons to rely to some extent on this metric, I would classify them as "conventional wisdom" as I did not see any mathematical evidence presented that actually supported the notion that there was a correlation between the length of time a company paid an increasing dividend and the likelihood it would not cut its dividend.

I reviewed past Seeking Alpha articles and found an article by Low Sweat Investing that referred to a couple of academic studies on the dividend cuts, one from Brandeis. The Brandeis study, itself, referred to a litany of other academic studies on dividends. I did not see one that examined the direct relationship between longevity and cut likelihood. I would, indeed, be grateful if someone could point me to a study that mathematically establishes a relationship.

I believe there are some good metrics available to determine the sustainability of a company's dividend. Consistent earnings growth, reasonable payout ratios, balance sheet capacity and wide moats are all things that experienced dividend investors examine before making an investment and as a regular part of their portfolio management routine (total return investors too!). I think it would be unwise for an investor to be lulled into a sense of complacency or comfort based solely upon the length of time a company has paid an increasing dividend (not that I am suggesting any investors actually do). In fact, I think a case could even be made to look at these other metrics even more closely as a company's dividend streak grows. Like I went to school when I probably shouldn't have, companies that have long dividend payment streaks are probably more likely to use balance sheet acrobatics to continue to increase dividends just to keep the streak alive. Of course, a positive side to this would be that it may give you a better early warning of an impending problem and a chance to get out before the event occurs, but that only works if you don't simply presume that because a company increased its dividend, that everything is "OK". This applies whether a company has been increasing its dividend for four years or forty years.

From the other side, there are a universe of dividend paying companies that have been paying dividends for less than five years or have cut their dividend within the past five years that should not be ruled out simply for this reason. I look at General Electric (NYSE:GE) as an example of the latter. GE cut its dividend in late February of 2009 (after 70 consecutive years of increases I must note) meaning it won't even be back on the five year lists until 2014. Nonetheless, even with the recent run-up in its stock price, it is still yielding about 3.6% and has increased its dividend twice in the past six months and 70% in the past two years. While it can be debated whether its current price is appropriate, I think few would argue that another dividend cut is likely for many years to come and I am guessing even fewer would argue that it is more likely simply because the dividend was cut within the past five years.

Of course, when considering this topic, it would be neglectful not to mention David Fish's CCC lists, which are three lists each based on the number of years a company has increased its dividend (5 to 9 - Challengers, 10 to 24 - Contenders, and 25 or more - Champions). None of this is meant to disparage, question or undermine the value of this work. I believe these lists are an excellent starting point for any investor looking to pursue a dividend growth investment strategy. I will further note, to Mr. Fish's deserved credit, I could not find any specific assertion from him that, for example, a Champion is less likely to cut its dividend than a Challenger or Contender. As he often wisely cautions "please consider this no more than a starting point for more in-depth research" ... something to keep in mind, in my opinion, when weighting the importance of this particular metric in your investment decision and portfolio management processes.

Disclosure: I am long SDY.