Will your dividends be cut or frozen?

Summary

• Dividend growth investors expect regular increases.
• What type of company decides to cut or freeze?
• What is the probability that one of your stocks won't boost the payout?

Introduction

Roughly half of the companies currently based in the USA pay dividends on an annual, quarterly, or monthly basis. Eight-tenths of the 505 stocks that comprise the large cap Standard & Poors 500 index provide such a payment to investors.

A significant subset of those companies regularly announce increased payments, usually annually. Lists of these so-called dividend growth (DG) stocks can be found documented by the DRIP Investing Resource Center (the Champions, Challengers, and Contenders or CCC) and the Dividend Aristocrats (DA). The DRIP site also contains lists for U.K. and Swedish stocks.

Many investors, especially those already in or preparing for retirement, would like to avoid interruptions in payments from their DG stocks. How can they do that?

I do it by picking and holding a basket of companies that eschew debt, return a reasonable proportion of earnings to investors, have a strong management team in place, and compete in a industry that provides a predictable flow of cash into the company coffers. Collectively these companies are what Lowell Miller, author of "The Single Best Investment", the bible of dividend growth investing (DGI), refers to as "high quality".

My DGI strategy uses the following criteria:

1. Yield at least 1.5 times that of the overall market (currently 2.6%) with extra consideration for 2 times or more.

2. Payout ratio based upon earnings and free cash flow of 0.6 or lower for all stocks except Real Estate Investment Trusts (REIT) and Master Limited Partnerships (MLP) which are required to pay out a higher portion of income.

3. Long term debt to equity ratio no greater than 1.0.

4. Credit rating Standard and Poors of at least BBB+. Credit ratings of A- or higher are preferred.

5. Long term (5 and 10 years) compounded annual average earnings and dividend growth rates of at least 5%.

6. Positive revenue growth over the previous five years.

7. Reasonable valuation: P/E (P/AFFO for REIT), P/S, and P/B are below the overall market average and industry and five-year average for the company; yield is above the 5-year average.

8. Annual dividend increases each year since at least 2002 (25 years or more preferred).

None of the companies I have purchased using the criteria above have ever cut the dividend.

Analysis of the CCC list since 2008

Stocks found on the Champions, Contenders, and Challengers (CCC) list have a history of annual dividend increases of 25 years or more, 10 to 24 years, and five to nine years, respectively.

A closer look at the companies that have cut the payouts during and after the 2008-2009 financial crisis indicates the following:

1. Most companies that have cut/frozen had streaks of less than 15 straight years. Those w/ streaks of 5-9 years performed poorly. For those companies w/ less than 15 straight years of increases the probability of cutting/freezing was 38%.

2. Companies w/ more than 15 straight years of increases had a 3% probability of cutting/freezing. For those companies w/ streaks of 25 years or more the probability was 2%. Those companies w/ streaks of 50 years or more had a low probability lt 0.6%.

3. Composite average for CCC list is a probability of cutting/freezing = 10% as compared to Div. Aristocrats = 4%.

History of the Dividend Aristocrats since 2008

Firms on the Standard and Poors Dividend Aristocrats list are included in the large cap S & P 500 index, meet certain liquidity and other requirements, and have boosted the dividend annually over the previous quarter century or longer.

A detailed look at the list since the financial crisis ended:

2009 - The list declined from 52 companies in 2008 to 42 companies in 2009, as ten companies cut their dividend payouts due to the 2008 financial crisis. They were: Anheuser Busch, Bank of America, Comerica, Fifth Third Bank, Keycorp, Nucor, Progressive Corp, Regions Financial, Synovus Financial, and Wm. Wrigley, which was bought. Also in 2009, there were two additions - Bemis and Leggett & Platt.

2010 - A second round of ten companies were dropped: Avery Dennison, BB&T, Gannett, General Electric, Johnson Controls, Legg Mason, M&T Bank, Pfizer, State Street Bank, and US Bancorp. Also in 2010, Brown Forman was added.

2011 - Three companies were added: Ecolab, Hormel Foods, and McCormick.

2012 - CenturyLink CTL was removed from the index after reducing its dividend from 72.5 to 54 cents per share per quarter. In addition, ten new companies were added to the index: AT&T, Colgate-Palmolive, Franklin Resources, Genuine Parts, Illinois Tool Works, Medtronic, Nucor, Sysco, T. Rowe Price.

2013 - Pitney Bowes was removed after slashing the dividend from 37.5c to 18.75c per quarter per share.

2014 - Bemis was removed from the S & P 500 index and therefore dropped from the Dividend Aristocrat list.

2015 - Family Dollar Stores was removed from the list due to its purchase by Dollar Tree. Also, Sigma-Aldrich Corp was removed from the list due to its acquisition by Merck.

2016 - Chubb Corp CB was removed upon acquisition by ACE Limited.

2017 - General Dynamics and the REIT Federal Realty Investment Trust were added to the list and HCP, Inc. was removed from the index due to spinning off HCR Manor Care and reducing their dividend. Also, CR Bard was removed from the list due to its purchase by Becton Dickinson.

2018 - Praxair, A.O. Smith, and Roper Technologies were added to the list.

Analysis

1. Some companies drop off the list due to financial issues, inclduing many banks. Notable non-banks were General Electric, Pfizer, Johnson Controls.

2. Some dropped off due to acquisitions/mergers.

3. A few were added and these companies performed well through tough times. These are the types of stocks that Lowell Miller would categorize as high quality and retirees/pre-retirees should consider for a portfolio. Example: AT&T and T.Rowe Price.

4. Lower quality/smaller companies (i.e. not on DA list but on CCC list) have a higher probability of cutting or freezing the dividend.

5. There are approximately the same number of stocks on the DA list today as in 2008 and the DA list has averaged about 50 stocks since inception in 2005.

Conclusion

Dividend growth investors expect regular increases to their quarterly or monthly payments. Companies that decided to cut or freeze the dividend in the past usually had smaller streaks of annual increases at the time.

Companies with longer streaks (since 2002 or earlier) had a lower probability of cutting/freezing.

Buying stocks of high quality companies that meet the appropriate criteria will decrease the probability of a cut of freeze.

Stocks that currently meet my criteria for DGI include National Health Investors, Inc. (NYSE:NHI), WEC Energy Group, Inc. (NYSE: WEC), and Magellan Midstream Partners, L.P.  (NYSE:MMP).