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Dividend cuts are often not good news, especially if you own a stock precisely for its dividend.
But, sometimes, a cut isn’t actually bad news, but that mostly depends on timing and cash.
Right off the bat, I’ve got to say that dividend cuts and suspensions are usually bad news.
Most cuts come because a company is simply out of cash. Let’s say earnings and free cash flow have been declining for whatever reason, depleting a company’s cash hoard. Or a company has taken on too much debt, to the point that the interest payments are getting too expensive.
Then a dividend comes due, and the company just doesn’t have the cash to pay it. In that case, the company doesn’t have a choice but to cut or suspend its dividend.
That is a bad cut.
The flip side of that coin is that companies do sometimes cut their payouts, even if they have enough cash to pay their dividends.
That usually happens when there’s a major recession looming, so companies decide they’re better off conserving cash in an uncertain business environment. That’s rarely a bad idea.
Or, there’s a major acquisition looming. In that case, the company cuts its dividend so it can put more cash down instead of taking on debt. That’s rarely a bad idea, either.
Another scenario: That market is in the tank, but the company and its fundamentals are still solid, but its stock is way down. In that case, it might create more value for shareholders if the company buys its stock back instead of paying a fat dividend.
Again, if you own a stock precisely for its dividend, any cut is never good news. But if a dividend is cut because of one of those last three scenarios, today’s cut might help ensure future dividend growth.
In which case, rushing for the exits might be a bad idea.
The only way you can really judge whether or not a cut is for a good reason or a bad one is to look at the balance sheet and cashflow statement, usually before the dividend is due. If it’s obvious the company will struggle to pay, it might be worth it to get out ahead of any cut.
If there’s still plenty of cash and assets on the books, though, the cut might not be such a bad thing.
Here’s to Profits,
Ben Shepherd