Should Retirees Worry About Dividend Cuts From Dividend Aristocrats?

Summary

• The list of dividend aristocrats has shrunken a lot over the last decade.
• Especially financial corporations cut or eliminated their dividends.
• The income investors get from a basket of dividend aristocrats can drop, but even during the last financial crisis the drop was rather small.
• Retirees should keep an eye on their holdings, but extreme fear about dividend cuts is not really justified.

Many retirees and other investors that rely on income from their investments put a big portion of their wealth into dividend growth stocks, especially those characterized as the so called dividend aristocrats. Due to the fact that the current list only includes those stocks that did not cut their dividends in the last 25 years, it looks like dividend cuts do happen very rarely, if at all. When we look at what companies made up that list before the financial crisis, we see that dividend cuts, at least during harsh economic times, are more likely than many investors believe.

In 2007, before the financial crisis, a big list of companies had increased their annual payout for at least 25 years in a row: These dividend aristocrats totaled 59 different companies. A significant portion of these companies have cut their dividends since or has otherwise ceased to pay dividends -- let's look at the list for both the dividend aristocrats from 2007 as well as those that still hold this status today:

The full list from 2007 includes the following companies (courtesy of Eddy Elfenbein):

Abbott Labs (NYSE:ABT)
Archer-Daniels-Midland (NYSE:ADM)
Automatic Data Processing (NASDAQ:ADP)
Avery Dennison (NYSE:AVY)
Bank of America (NYSE:BAC)
BB&T Corporation (NYSE:BBT)
Bard (C.R. Bard) Inc. (NYSE:BCR)
Becton, Dickinson (NYSE:BDX)
Anheuser-Busch (NYSE:BUD)
Chubb (NYSE:CB)
Compass Bancshares
Cincinnati Financial (NASDAQ:CINF)
Clorox (NYSE:CLX)
Comerica (NYSE:CMA)
Century Telephone (NYSE:CTL)
Dover (NYSE:DOV)
Consolidated Edison (NYSE:ED)
Emerson Electric (NYSE:EMR)
Family Dollar Stores
First Horizon National (NYSE:FHN)
Fifth Third Bancorp (NASDAQ:FITB)
Gannett (NYSE:GCI)
General Electric (NYSE:GE)
Grainger (W.W.) Inc. (NYSE:GWW)
Johnson Controls (NYSE:JCI)
Johnson & Johnson (NYSE:JNJ)
KeyCorp (NYSE:KEY)
Kimberly-Clark (NYSE:KMB)
Coca Cola (KO)
Leggett & Platt (NYSE:LEG)
Lilly (Eli) & Co. (NYSE:LLY)
Lowe's (NYSE:LOW)
McDonald's (NYSE:MCD)
3M Company (NYSE:MMM)
Altria (NYSE:MO)
M&T Bank (NYSE:MTB)
Nucor (NYSE:NUE)
PepsiCo (NYSE:PEP)
Pfizer (NYSE:PFE)
Procter & Gamble (NYSE:PG)
Progressive (NYSE:PGR)
PPG Industries (NYSE:PPG)
Regions Financial (NYSE:RF)
Rohm & Haas
Sherwin-Williams (NYSE:SHW)
Sigma-Aldrich
SLM Corporation (NYSE:SLM)
Synovus Financial (NYSE:SNV)
Questar (NYSE:STR)
State Street (NYSE:STT)
Supervalu (NYSE:SVU)
Stanley Works (NYSE:SWK)
Target (NYSE:TGT)
U.S. Bancorp (NYSE:USB)
V.F. Corp. (NYSE:VFC)
Walgreen (WBA)
Wal-Mart (NYSE:WMT)
Wrigley

A whopping 26 of these companies are not on the dividend aristocrat list any longer, due to different reasons:

Companies that got bought out:

Compass Bancshares, Family Dollar Stores, Rohm & Haas, Sigma-Aldrich and Wrigley got bought out and are thus not independent companies any longer, thus not anymore on the dividend aristocrat list either. For those who owned shares of these companies this hasn't been a bad investment though, as investors either could hold / buy shares of the acquirer and get dividend income from that company, or were paid out in cash and could deploy that money into other dividend growth stocks.

Anheuser-Busch could be counted into that group as well, since the company merged with InBev to create AB InBev as we know it right now.

Companies that froze their dividends:

There are a few companies that did not lower their payouts, but stopped rising their dividends, thus dropping of the list as well, those include Johnson Controls (which has since started raising its dividends again), Lilly (which has resumed dividend growth again as well) and M&T Bank (which since has started its payout again as well). In general holding the shares of these companies did not turn out as a big problem, as they all kept their payouts stable before starting to increase their dividends again -- investors missed out on a little bit of dividend growth, but their income did not take a hit.

Companies that cut their dividends:

Unfortunately a couple of companies cut their payouts, including Bank of America, Avery Dennison, BB&T, Comerica, Century Link, First Horizon, Gannett, General Electric, Keycorp, Pfizer, Regions Financial, Synovus Financial, State Street and US Bancorp.

Altria (the old Philip Morris) has cut its dividend after it spun off Philip Morris, but due to the fact that the combined payout was not lowered, investors who held Altria (and kept their Philip Morris shares) did not see a cut to their total income.

The other 14 companies did reduce their payouts though, which hurt the income streams of those investors who held their shares. We see that this list is heavy on financials, which isn't surprising due to the fact that financial corporations were hit hardest during the subprime and financial crisis. Due to its huge banking business back then GE could have been put into the financial basket back then as well.

Many of these companies have since started to increase their dividends again, such as Bank of America, which has just raised its payout by 60%.

Companies that eliminated their dividends:

Progressive Corp., SLM Corp. and Supervalu have eliminated their dividend payments completely. With Progressive and SLM this list is primarily made up by financial corporations as well, once again not a big surprise.

The original list included an outsized number of financial institutions, diversifying and putting not too many eggs into one basket would have allowed to limit the impact of the big cuts in this sector.

Now that we know which companies have lost their dividend aristocrat status over the last ten years (and why), let's look at what would have happened to an income focused portfolio after 2007:

For this list I excluded those companies that were acquired. I also assumed an equal weighted portfolio (for simplicity, $1000 put into each company at the beginning of 2007).

We see that an investment of $49,000 made at the beginning of 2007 would have resulted in annual income of $1364 in that year, and an income of $1142 in 2010. This means a yield of 2.8% and 2.3%, respectively. The annual income would have dropped by 16% over those three years.

Are the dividend aristocrats safe from dividend cuts and are investors who invest in those safe from declining income generation? No on both counts, but the risk is still pretty tolerable, I believe: The last financial crisis was a very severe one, and the dividend aristocrats were heavily overweighed in the financial sector -- but even combining these two risk factors, the income investors got from a basket of dividend aristocrat stocks declined only slightly.

As long as investor plan for some margin of safety (such as annual dividend income that is 20% to 30% higher than their cost of living) and / or have enough cash on the side to cover a temporary shortfall in dividend proceeds, even a very big financial crisis (such as the last one) does not threaten the retirement planning of dividend growth investors in a meaningful way.

Takeaway

The list of dividend aristocrats has shrunken significantly over the last ten years, mainly due to dividend cuts, but also due to M&A and other factors. Investors who were living from their dividend proceeds prior to the financial crisis would have seen a 16% income reduction from an equal weighted dividend aristocrat portfolio -- since dividend proceeds are usually not the only source of income for retirees, the actual hit to their annual income would have been even smaller.

Planning with some margin of safety allows for relatively low-risk retirement with a diversified basket of dividend growth stocks, especially since a financial crisis such as the last one is not very common.

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Analyst’s Disclosure: I am/we are long JNJ, MO, PFE, WMT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.