Dividend Safety Is More Important Than Ever, Here’s Why

Dividend And Buyback Cuts Loom Large

When talking about dividend investing the health, or safety, of a dividend is a crucial aspect. If a dividend is health, if the company is having trouble paying it or by paying it incurs debt, there is a risk the distribution will be cut. When companies cut their distributions their stock prices fall and investors lose their hard-earned capital.

With the viral-crisis spreading, more and more companies are finding it prudent to cut or suspend their payments. In some cases, the move is precautionary and intended to preserve capital. In others, it’s because revenue streams are drying up, cash flow has ceased, and dark, dark times lie ahead.

News today includes dividend actions by two of the markets most stalwart payers, Ford (F) and Darden Restaurants (DRI), so the carnage will not be limited to weak names. In both of these cases, the move is precautionary but, also in both cases, the timing of the virus and the length of the impact could alter the outlook drastically.

Ford, at least, only has one headwind; consumer confidence. With the virus shutting down work, discretionary spending on cars is coming to a halt, and that is assuming Ford can reopen its plants to meet whatever demand there is. Darden is a different story. Restaurants are places where large groups of people come into contact with each other and will likely suffer fallout for months after the sickness has passed.

Shares of Ford are down 7.5% in premarket trading this morning after falling more than 10% on Wednesday. Shares of Darden opened the session with losses near 7.0% following a double-digit decline in the previous session. Both stocks are trading at decade lows and appear to be heading lower.

What To Look For In A Dividend Stock Today

1. Revenue - All dividends start with revenue. No company I want to invest in can pay dividends without revenue. Ford and Darden are both facing a revenue crisis but that is not the case for all businesses. Amazon (AMZN), for one, is getting upgrades based on the viral outbreak and the increase in demand. Other stocks in this position are Chewy (CHWY), an eCommerce pet store, and Kroger (KR). Kroger made headlines earlier this month when it announced a massive hiring spree to cover demand in its stores. Sectors to avoid now include Airlines, autos, hospitality, food & beverage, and retail. ECommerce, grocery, consumer staples, and utilities are all good targets for revenue.

 

2. Earnings - While revenue is where dividends start, it is the earnings or profits from which they are actually paid. Good dividend payers will have positive earnings and at least a stable outlook for future earnings. If a companies earnings are expected to decline you can also expect the dividend to decline and that is not good for your total returns. Total returns is the net gain on an investment that includes dividends paid and capital gains (losses). The tech sector is, believe it or not, a great sector for EPS growth this year. Accenture (ACN) just reported earnings for the 1st quarter, beat on the top and bottom lines, and guided for growth despite lowering their estimates. That stock is up 4.5% in today’s action and looks like it is trying hard to put in a bottom.

 

3. The Payout Ratio - There are several methods of measuring the safety of a dividend but the first thing to check is the payout ratio. The payout ratio is a measure of a dividend’s size relative to a company’s earnings and a pretty good indication of its health. A high payout ratio shows a company is paying most of its earnings in dividends. If this company doesn’t have stable revenue and earnings, or if the cash position is poor, or the company is highly leveraged, there is a higher risk the distribution will be cut. The trick with payout ratios is a “healthy” payout ratio will vary from industry to industry. REITs are in business to pay dividends so often have ratios in the range of 80%. For most equities, I like to target ratios below 65% and the lower the better.

Accenture Is A Great Example Of A Virus Proof Dividend

Accenture is a global consulting and outsourcing firm focused on the tech industry. Accenture services clients in all business segments and works with all major tech platforms. The basis of the business is helping set up and train staff in the use of business technology and business is booming.

The company just reported earnings for the 1st quarter and only gave one negative in the report. Guidance for the full-year 2020 was lowered to revenue growth in the range of 3.0% to 6.0%, about half the previous expectation. Even so, EPS is growing and the company’s payout ratio is very low at 39.0%. The yield is a bit low, only 2.0% compared to the broad S&P 500, but I think that 2.0% will look pretty good after a few more big names cut their payments.