How to protect yourself from the death of dividends
It will take time for payouts to return to their former glory, so investors should build up cash reserves and look for funds that can withstand the coronavirus crisis
Are you an income investor? Meaning, do you rely on dividend payouts to supplement your current spend, and/or have it at the heart of your plans to fund retirement?
If so, you're probably feeling a bit hot under the collar.
More companies have suspended or cancelled dividend payouts this year than over the past decade.
Of those that are still paying out, some are slashing amounts; for example, Anglo-Dutch oil and gas company Shell cut its payout for the first time since the Second World War.
You're at your most vulnerable if you are due to retire soon or have just retired, and plan to live off your portfolio dividend payout. The thing to look out for here is not to eat into the capital invested – and learn to draw, or live on, less.
For those in the building phase, the standard wisdom is: don't worry. Things will even out over time. Long-term investors are encouraged to see dividend cuts as an attempt by companies to protect their balance sheet and defend shareholder value. In other words, a company like Shell cutting its dividend is doing so to invest in its future.
Part of the problem lies in the stellar payouts recorded last year – $1.43 trillion (Dh5.25tn) was paid in dividends worldwide, according to asset management company Janus Henderson. The firm had forecast a rise of 4 per cent in payouts this year, but that was BC – before corona.
Even income investors who are a way off retirement have come to depend on these payouts and factor this cash in annual spend. Like a family I know who have paid their three children's school fees thus far with windfall gains from dividend payouts.
Even if economies recover, dividends might not return to their previous highs for the foreseeable future while companies build in more resilience to business disruption.
Plus, corporations that have benefited from state help will be barred from giving out dividends. And there's talk of corporate tax being raised in order to help with the huge economic costs resulting from the pandemic.
Regulators prioritising supporting economic activity over shareholder payout is another possibility – specifically in the banking sector.
All these things mean it might be a long time before dividend payouts go back to the levels seen last year.
In the meantime, let's look at a couple of theories that are often cited when making the case for dividend-paying investments:
First: the assumption that high yield is king. Find out the dividend-payout ratio, not the yield. You'd be forgiven for wanting to stock up on a collection of the highest dividend paying stock and hope for the best. But remember, a dividend is a percentage of a business’s profits that it is paying to its owners (shareholders) in the form of cash. Any money that is paid out in a dividend is not reinvested in the business.
The dividend-payout ratio is the proportion of the company's earnings paid out as dividends to shareholders, typically expressed as a percentage. If a company pays out all its earnings to shareholders, then there is no money in the pot to invest in the company, or to protect against uncertain times.
Second: dividend stocks are safe. The current environment shows us this isn't always the case, despite many of them being top-value companies.
Now for a glimmer of good news: no payout now does not mean the cash doesn't exist – it could be available for next year. It could even mean a higher payout in future. No one knows.
What happens with dividends is not something you can control, so here is what you can control:
Build up your emergency fund and cash-cushion to cover you for two to three years' expenses – so you're ready for 'next time' – not the six to 12 months traditionally mooted.
And while you're at it, I suggest you check whether a woman runs the show – women-led hedge funds beat male rivals during this corona crisis era. Women-led funds lost 3.5 per cent in the first four months of this year, according to the Chicago-based data group HFR's Women Access Index, compared to 5.5 per cent for the broader index.
In 2018, investment research firm Morningstar found that funds run by all-female teams performed better than those wholly managed by men, returning 1 percentage point more over a five-year period.
So there you have it. The key takeaways:
• Look at the dividend-payout ratio, not yield.
• Dividends are not a given.
• Build up cash reserves to last two to three years.
• Look for funds managed by women.
And good luck if you depend on payouts to pay your life's expenses right now!
Nima Abu Wardeh is a broadcast journalist, columnist, blogger and founder of S.H.E. Strategy. Share her journey on finding-nima.com
Updated: June 4, 2020 05:02 PM