A Dividend Cut Might Actually Be an Opportunity

by: Clay King

There is a great deal of belief by many that when a company cuts its dividend that the shares should be sold. That, at least to me, ran counter to my experience of 30 plus years of trading under my belt. More often than not, when bad news is announced after a long and lengthy decline, that event often pinpoints the climatic end of the decline marking a excellent buying area. Conversely, the time to sell a stock is often after the good and expected news is released.

Selling shares is more likely to be viewed as a trading opportunity due to stocks' natural tendency to rise year to year. Now, I understand an income investor wishing to sell the shares as it no longer produces the desired income. But, might it also be the right time to buy the shares for appreciation, as well as future dividend income as these companies try to retain their premier status, perhaps quickly?

One only needs to look back several years to see the dividend champions and aristocrats that fell by the wayside during a poor economic period. After years and years of steadily increasing their dividend, economic forces compelled these companies to slash dividends in order to restore their balance sheet. However, out of this fundamental bad news, comes good. General Electric (NYSE:GE), after 100 years of growth building one of the world's best known franchises, was forced to cut its dividend. I had to ask myself at the time if this was the end of GE, or if it was a great buying opportunity?

With that thought in mind, I selected nine names from a list of 21 companies that cut their dividend from 2008 to 2009. Fifteen of those names were financial so just a few of those were chosen to research. My goal was, and always is, to find the truth and kick all bias aside. I tried not to cherry pick from the list of dividend cutters that I had, but did try to spread the sectors around to attempt to avoid 90% plus financials.

The table lists the company, the date the dividend cut was announced, the stock's return from the date announced and the return in the S&P 500 during the same time frame. The cut off date was 5/13/2011.

Company Div. Cut Ann. Stock Return S&P Return
Bank of America 10-6-2008 -41% +57%
BB&T 5-11-2009 +29% +57%
Wells Fargo 3-6-2009 +231% +104%
General Electric 2-27-2009 +66% +59%
La-Z-Boy 2-19-2009 +987% +82%
Legg Mason 5-5-2009 +62% +50%
Lincoln National 10-10-2008 +26% +57%
Masco Corp. 2-12-2009 +117 +69
Pfizer 1-26-2009 +61 +70
Total Returns Average +170% +67%
Returns ex. La-Z-Boy +68.875% +65.375%

From the results of this limited study, but fair in all respects, I would have to strongly consider any stock that cuts its dividend after a long slide in price as a candidate for purchase. Though the La-Z-Boy return is real, the results are still favorable even removing it from the study. In addition, 6 out of the 9 stocks are found within the financial sector, hardly a sound portfolio. As can be noted above, several of the companies announced a dividend cut very close to the actual bottom of the market, further cementing the "buy when blood is running in the streets" theory.

Conclusion: By no means should a dividend cut be used as a buy signal, nor should it be construed as a sell either. The next time one sees a bad news announcement from a company, do not take it as negative, take it as a possible opportunity to buy, not sell. It goes against the gut, which when trading stocks is so often the correct trade. At least make the effort to investigate before making a knee jerk reaction to sell.

Disclosure: I am long GE, PFE, BBT.