February 3, 2013

Dividends Are Not That Safe

I generally like the idea of investing in stocks that pay good dividends.  This has been a strategy of mine with my Roth IRA investments.    I was using a High dividend stock strategy in 2008 but at that time as I said it wasn't hard to find blue chip stocks paying 4-7% yields and ETFs yielding 4-9%.  That was a reflection of the stock market being full of bargains at the time.  Nowadays yields from dividends aren't as high and stocks aren't as cheap in general.

When you've been writing a blog for nearly five years like I have you sometimes end up repeating yourself.   I first wrote about this topic in 2009 with the article Are There Safe Dividends? and I pointed out then that dividends really are not 'safe'.   I found out myself after GE slashed their dividend not long after I had bought them.   I later questioned Why Do I Own GE Stock?

Of course it wasn't just GE that cut their dividend.   A lot of major companies cut dividends during the financial crash around the Great Recession.

Lets look back at the Dow components from 2008.

8 of the 2008 Dow components  have since had dividend cuts:
Bank of America (BAC) down from 0.32 to .01
Alcola (AA) slashed dividend from .17 to .03
American International Group (AIG) went from $4.40 to 0
Citigroup (C) cut their dividend a few times from $5.40 to $3.20 then $1.60 then finally to 0.10 after 1:10 split
GE from .31 to .10 like I mentioned
General Motors - bankrupt from 0.25 to 0
JP Morgan Chase (JPM) - 0.38 to 0.05 back up to 0.3
Pfizer (PFZ) .32 to .16 but the up to .22


Now not all those stocks are still on the Dow as the Dow changes gradually over the years  as some stocks are removed and others added.

Thats just over 25% of the Dow components from 2008.   And these are the big name blue chip companies that are generally safer and more established.

Now this is not to say that investing in dividend paying companies isn't a good strategy.  But you shouldn't put too much faith in the future payout rates on those dividends.   I see people building dividend paying portfolios with the intention of building a passive income.  If you'd done that in 2007 and bought up Dow stocks then retired early with the intention of living off the dividends then you might have been in for a nasty ~25% cut in income come around 2009.


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3 comments:

  1. Do you have any suggestions on how to build a passive income portfolio? I've gotten to the point where I am maxing out contributions to my 401k and Roth IRA, so I'm starting to think about taxable investing for "financial independence" purposes. I'm just kind of stuck right now on where to start.

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  2. I concur. I've also noticed there is more turnover than I would have initially guessed in these list of companies that have raised dividends for a certain number of years. I wonder if there is some way of screening for some of this risk beyond the traditional payout ratio. I wonder whether companies with high financial or operating leverage are at a greater risk to cut in a recession? I note 4 of the 8 companies you listed were financials, which by nature have high financial leverage (i.e debt). GE also has high financial and operating leverage (fixed costs) and so does GM. Alcoa has high operating leverage. PFE seems to have a unique set of issues.

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  3. S.B., I would imagine that leverage and debt levels might come into it. I'd also think that the dividend 'payout ratio' would be something to look at. I would suspect that companies with higher ratios would be more likely to make dividend cuts if they hit hard times. But I haven't looked at it and I don't know how high the correlation is. Also I don't know how well people could have predicted the recent recession and the fallout it caused.

    Jim

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