Wednesday, January 27, 2010

Stocks with fluctuating dividends to avoid

Many investors who are looking for an income stream in retirement choose the relative safety of US Treasury bonds. While the coupon payments lose their purchasing power each year due to inflation, they are fixed and guaranteed by the US government. This makes budgeting expenses somewhat easier. With dividend stocks on the other hand, distributions are not guaranteed which is probably why pundits advise retirees to increase their asset location in fixed income instruments. This is despite the fact that for most US companies which pay dividends, distributions do not fluctuate.

Most companies try to get a following from long-term investors by enticing them with a stable or growing distribution over time. That way there is a greater chance that those investors would not sell even under the best or worst of circumstances. If dividend growers have a stable business model which allows them to pass on cost of increases to their customers while still earning a respectable return on capital, they could afford to raise distributions to their stockholders. Stocks that pay rising distributions could essentially provide investors with a real inflation adjusted stream of income, which is something that most fixed income securities do not provide. This makes it easier for investors to budget for their expenses, since their revenues would now be keeping up pace with inflation. One issue with these payers however is that they offer yields ranging from 3% to 5%, which is not enough for some investors.

Not all dividend stocks pay a stable distribution however. Some high yielding but speculative stocks which investors hold pay dividends which fluctuate from quarter to quarter. Companies which pay all of their operating earnings are typically the ones which pay fluctuating dividends. Examples include Canadian royalty trusts such as Pengrowth (PGH), PennWest (PWE) and shipping companies such as Nordic American Tanker (NAT). These stocks spot high yields most of the times, which might not truly reflect the yield on cost of original holders. Pengrowth Energy (PGH) for example yielded 15.30% at the end of 2007 while paying out a distribution of 22.70 cents monthly. Two years later it paid out a distribution of 6.70 cents/share, while yielding 8.40%. Obviously investors who purchased the stock in 2007 are not earning as much on their invested capital as they had originally planned to do- their yield on cost was 4.50% by the end of 2009.

Another example of this situation is Nordic American Tanker which has paid a quarterly distribution ranging from a low of 30 cents/share to a high of $1.88/share. Investors who relied on the high dividends which NAT paid must have been terribly surprised when the company announced a quarterly distribution of just 10 cents. Having limited to no visibility as to what the distribution might be next quarter could impose a strain on an already thin retirement budget.

The stocks which investors should concentrate on are the ones which pay a stable and growing distribution, which are adequately covered by earnings. That way investors’ portfolios would not be exposed to temporary fluctuations in earnings, which would affect the amount of dividend payouts. Companies, which pay consistent dividends, pay out up to a certain sustainable amount of their earnings to shareholders as dividends. They reinvest the rest in the business, which could bring in a solid foundation from which further growth in earnings and distributions is achieved. While there is always a risk that a company could slash or eliminate its distribution, few regular dividend growers do that unless they face unforeseen circumstances.
An example of such stock is Abbott Labs (ABT) has increased dividends for 37 consecutive years. Abbott Laboratories manufactures and sells health care products worldwide Check my analysis of the company.

Full Disclosure: Long ABT

Relavant Articles:

- Best Dividends Stocks for the Long Run
- High yield Canadian Royalty Trusts
- High yield stocks for current income
- The Dividend Investment Journey
- Dividends Stocks versus Fixed Income

1 comment:

  1. Unfortunately as we saw in 2009 even solid long term Dividend Aristocrats can reduce or eliminate their dividend in difficult circumstances - i.e. GE, PFE, BAC etc.

    The best is to have a portfolio of Dividend Aristocrat type stocks, some preferred shares and treasury bills to provides security.

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