Tuesday, April 14, 2009

Should you sell after a dividend freeze?

One of my main objectives as a dividend growth investor is to seek investments which have a strong business model that throws out enough cash flow that could support consistent dividend increases. My secondary objective is managing risk within my portfolio, by eliminating stocks, which have cut their dividends, by not reinvesting the dividends in companies that freeze their dividends and by diversifying my investments across sectors, asset classes, strategies and time. So far, based off my research of performance of dividend stocks based on company policy in addition to my experience over the past few years, I have been able to grow my income stream successfully.

Recent evens have reinforced my ideas on selling after a dividend cut. However an article from fellow blogger DividendsValue presented an interesting analysis in “Should You Sell A Dividend Stock After A Dividend Freeze?”. As an investor who is always looking to improve my performance, this article made a lot of sense. Dividend freezes, or the failure of a company to increase its dividends once an year, have certainly been a strong forecasting indicator of future dividend cuts. So far I have had several stocks on my radar which have frozen their dividends, only to cut them a few weeks later:

General Electric (GE) failed to increase its dividends on December 2 when the stock was trading at $17.61. The company cut its dividends on February 27, when the stock was trading at $8.51.

State Street (STT) announced that it wouldn’t be raising its dividends on December 18, when the stock was trading at $39.06. The company cut its dividends on February 5 when the stock was trading at $27.54.

Gannett (GCI) failed to increase its dividends on July 31, while the stock was trading at $18.12. The company announced a 90% dividend cut on February 25, when the stock was trading at $3.75.

Pfizer (PFE) failed to reward shareholders with an increase in dividends on December 15, when the stock was trading at. The company announced merger talks with Wyeth on January 26 as well as a 50% reduction in dividends, which drove the share price to $15.65.

Bank of America (BAC) affirmed its payment on July 23 when the stock was trading at $33.30. The bank cut its dividend on October 6 when the stock was trading at $32.22.

In all cases, selling after the announcement of a dividend freeze would have saved you from suffering further losses, especially if you had been waiting for the dividend cut news to sell your stock.

There are several companies, which I follow which have failed to increase dividends recently:

In July M&T Bank (MTB) kept its dividend unchanged. Unless the company increases dividends over the next two quarters it would lose its dividend aristocrat status. (analysis)

Cincinnati financial (CINF) kept its dividend unchanged for five quarters in a row at its February 2 announcement. The company has 2 more chances to increase its dividends; otherwise it would lose its dividend aristocrat status. (analysis)

In both cases I am holding on to the stocks, as long as the dividends are not cut.

After reading the article by DividendsValue I hesitated whether to hold on or to sell. After comparing returns of stocks with unchanged dividends to dividend growers and initiators I found that a dividend freeze might not be a bad thing. Furthermore I doubt that one should adjust their portfolio strategy based to follow the past market action too closely. In the past stocks like WYE, K, UST, GIS have frozen their dividends, but several years later resumed growing their payments. All of them were members of the elite dividend aristocrats index, and got kicked out for keeping their dividends unchanged.

Wyeth (WYE) failed to increase its dividends in 2000 a three-year losing streak in the mergers and acquisitions game for WYE. The company began increasing its dividends again in 2005. The ten year average annual dividend growth is 3.30%. Wyeth is currently in merger talks with Pfizer, as it is one of the few pharma stocks which are actually holding a stable pipeline that delivers drugs to the market.

Kellogg (K) kept its dividend unchanged for over 6 quarters before it was kicked out of the S&P Dividend Aristocrats index in 2002. This was due to the timing of dividend increases by the company. In 2005 Kellogg started raising its dividends once again. The average annual dividend growth for the company is 4.20%.

US Tobacco (UST) didn’t increase its quarterly dividend in 1997 and kept it unchanged until early 1999. After that followed a decade of consistent dividend growth of 4.60% annually and a buyout by Altria Group (MO) in 2008.

General Mills (GIS) failed to raise its dividend in 2000 and kept it unchanged until August 2004. Nevertheless the Minneapolis, MN based manufacturer of branded and packaged consumer foods managed to deliver an annual average dividend growth of 5.10% over the past decade.

An investor has to ask himself or herself what happens if a company freezes its quarterly dividends, and 5 quarters later it increases the dividends again? On an annual basis your dividend income from the stock could still be increasing.


I wouldn’t like to optimize my strategy solely based off the performance in recent years.
As a dividend growth investor an unchanged dividend is not necessarily bearish news for me. Most companies don’t raise their dividends every year, but still could achieve a decent dividend growth rate. If I could exit the position at least at breakeven however, I would most probably invest in companies which could support an increasing dividend payments even during cyclical downturns.

Full disclosure: Long CINF and MTB

Relevant Articles:

- The Dividend Edge

- My Dividend Growth Plan - Strategy

- Should you sell after a dividend cut?

- Dividend Aristocrats List for 2009

- Historical changes of the S&P Dividend Aristocrats

4 comments:

  1. Thanks for the mention! BTW, I too am still holding MTB.

    Best Wishes,
    D4L

    ReplyDelete
  2. Do you know what the dividend payout ratio was for the companies that froze dividends and then slashed them afterwords?

    ReplyDelete
  3. D4L,

    I should have sold MTB last year when they banned short selling on financial stocks.. I am selling covered calls against my position there for some extra dough..

    TMW,

    That's a very good question.
    GE earned 1.78 in 2008 and paid 1.24 in divs. The situation at GE deteriorated after its 1Q 08 earnings release..

    GCI had a negative EPS but this was mostly due to some cleaning the balance sheet frmo intangibles.

    STT earned 4.95 in 08 and paid 0.95 in divs. STT should not have cut the dividend.

    Pfizer and BAC had unsustainable dividend payout ratios..

    ReplyDelete
  4. Thanks. I think you know where I am going with this... if a CEO stands up and says we will not cut the dividend but the payout ratio is unsustainable, he is blowing hot air. It is easier to trust numbers than press releases.

    ReplyDelete

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