Friday, February 6, 2009

My take on State Street’s dividend cut

Yesterday, the board of State Street (STT) announced that they would be cutting the quarterly dividend from $0.24/share to $0.01/share. STT joined the ranks of other financial institutions such as Bank of America (BAC) and Citigroup (C) with in this move to bolster liquidity. After reading this announcement I immediately sold all of my STT holdings. I also plan on removing the stock from my Best Dividend Stocks for the long run list.

The reason why I purchased STT in the first place was the fact that it was the only dividend aristocrat that had a long history of consistent dividend increases. In fact for the past 27 years STT had been increasing its dividends twice a year, which is the only dividend aristocrat to do so. Asides from the growing dividend, I also liked the fact that the company was engaged in Investment Servicing and Investment Management. STT also has managed to deliver an 11.20% average annual increase in its EPS between 1998 and 2007. In addition to that, the dividend was adequately covered, with the dividend payout ratio never exceeding 30% over the past decade.

As a result of the dividend cut and the other moves, State Street revised its previously reported 2008 earnings to $4.30 per share from $3.89, which also boosts return on shareholder equity. The steps were taken as part of a plan to strengthen State Street's tangible common equity ratio, which is a measure used to compare the bank's capital adequacy with its goodwill and other intangible assets. 2009 earnings are expected to be between about $4.94 and $4.71 per share. It also eliminated bonuses for its top five executives for 2008 and roughly halved incentive compensation for the rest of the company.

I did see the situation at State Street worsening, after it received TARP money and especially after it announced no intention to increase dividends for the time being after reporting lower than expected quarterly results last quarter. This has put the dividend aristocrat on a danger list to be kicked out of the prominent dividend index. S&P would most probably remove this financial company from the elite group of dividend companies pretty soon.

Despite the warning signs however, I still believed that the dividend would not be cut, because it was very well covered. I strongly doubt that STT management believes in their ability to deliver 2009 earnings, exactly because of the dividend cut. If it were really convinced that 4.71 to 4.94/share was achievable in 2009, then paying out a measly 0.96/share wouldn’t have changed anything that much.

This is my second dividend cut in my portfolio since the start of the financial crisis. In the meantime I will be inspecting more closely any financial related holdings in my portfolio and assessing the risk of further dividend cuts in the future. I will also look for other companies to replace STT in my dividend portfolio.

Full Disclosure: None

Relevant Articles:

- TARP is bad for dividend investors
- Dividend Aristocrats in danger
- State Street Corporation (STT) Dividend Stock Analysis.
- Best Dividends Stocks for the Long Run
- Dividend Cuts - the worst nightmare for dividend investors

2 comments:

  1. What evidence do you have that selling dividend stocks after they cut their dividends is a good investment strategy? The market almost always anticipates the cut, and as such the stock will have already taken a good chunk of it's fall.

    If the objective is to preserve capital and sustain income, are you not simply trading down mechanically? i.e. every time a holding cuts it's dividend, you sell it taking a capital loss, and in an attempt to sustain income buy something else with a high yield. Almost by definition you've lost money and increased risk in this trade.

    The trade may or may not make sense from an analytical perspective -- that's not my point. But does the mechanical nature of the designs get you any further ahead?

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  2. Matt,

    Apparently you haven't been reading my blog for the past several months. Dividend Cuts typically show that management is facing something completely out of their control or that mgmt is seeing severe future deterioration in financial performance/stability of the enterprise.Divs are a sacred cow that rarely get cut in US. Once mgmt dissapoints incoem seeking investors with a dividend cut, then there is nothing else to stop mgmt from eliminating the dividend or cutting again. For reference, check all the other financial companies in 2008 - like BAC and C. Had you sold your BAC or C right after they cut divs initially, you would have protected your capital.

    As for selling cutters, yes it is a good strategy as dividend cutters and eliminators have underperformed the S&P 500 between 1973 and 2004.

    I am ok taking a loss, it doesn't scare me to admit I have been wrong with selecting a dividend investment that ends up cutting the payment.

    I never buy anything with a high yield. I never bought BAC or PFE for example and even warned readers of my blog in July 08 that their payments are not sustainable. I buy dividend growth stocks.

    I wonder why people are so averse to taking a loss when their initial reasons for entering an investment are no longer valid? Many investors were hoping that Citi and BaC will not cut divs again and that everything will somehow get miraculously better, only to suffer huge losses. Furthermore, check the timing div cuts in some "famous" companies such as Freddie, Fannie , Wamu. If you had sold at that moment you would have saved a ton of capital.

    Now there is always the possibility that you sell at the bottom. In this case I could buy back stock when it initiates/increases its dividends.

    ReplyDelete

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