Dividend investing may be dead… at least for now.
For a company to pay out dividends, it has to make money (the one exception to this is the financial sector which now resorts to using government money or simply issuing more shares in order to maintain dividend payments).
When times are good, this means that a “buy and hold” strategy can result in yields far, FAR greater than the company’s listed payouts. For instance, let’s say you buy shares of ABC company at $10 a share yielding 10% (a dividend payout of $1.00). Now, if ABC increases its dividend by just 5% a year, within ten years you’re collecting a 16% yield ($1.62 per year on your original buy price of $10).
Thus even if ABC’s listed yield remains 10%, you’re actually collecting 16% a year. Pretty sweet, right?
But what happens if ABC company starts making a lot LESS money? Let’s say the economy goes in the dumps (like today). Or even worse, let’s say consumer spending habits undergo a seismic shift resulting in FAR less shopping and sales (also like today).
Welcome to dividend investing today:
Source: John Mauldin, Millennium Wave Advisors
The above table shows expected 2009 earnings for the S&P 500 starting in March 2008. As you can see, over the last year, analysts have lowered their earnings estimates dramatically (that’s putting it mildly).
According to Bloomberg, 288 companies cut or suspended payouts at the end of 2008. That’s the largest drop since Standard & Poor’s (S&P) records began 54 years ago. In fact, predictions based on dividends show shares today are overvalued by more than 46 percent.
All told, the reduction in dividend payouts at the end of 2008 exceeded ALL reduction for the years 2003-2007 COMBINED. Companies listed on the S&P 500 are expected to trim payouts by an additional 13% this year: the largest drop since 1942.
If you’re looking to invest based on a company’s dividend payouts, think again. That yield you’re looking at may in fact be a mirage. And when the company cuts its payouts, share prices will plummet.
My advice: take a long hard look at the company’s financial statements. Can the company continue to meet dividend payments even if earnings fall another 20%? How quickly did sales evaporate during 2008? Has the company already cut its dividend payouts in the last 12 months? If so, by how much?
It’s also worth considering how far back the company’s dividend payouts go. Did the company maintain dividends during the last major recessions (early ‘90s, early ‘80s, etc)? If so, you might have a good chance of getting a decent return during this downturn.
To return to my original thesis: companies need to make money to continue their payouts. With earnings falling off a cliff, dividends will be cut, and dividend investing will be a LOT harder. So make sure you do your homework before investing based on yield.
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