investing

What to do when companies cut dividends  

Highlights
  • What to do when your dividends are slashed
  • Predicting cuts before they happen
  • Keep a sense of perspective

The recent news about stock dividends seems grim.

In 2008, a record 62 companies in the Standard & Poor's 500 index cut their dividends, amounting to nearly $41 billion in lost payouts. Another $30 billion of S&P 500 dividend reductions occurred in just the first two months of 2009, more than the preceding quarter's record-breaking total, the S&P says.

With more industry giants slashing dividends, are dividends still a smart source of income for conservative investors? What does it mean when a company cuts or eliminates its dividend? Is there any way to predict the sustainability of dividends from your particular stocks? And where can investors turn for comparable, reliable income if their dividends are trimmed?

Be prepared
  1. No easy solutions
  2. What to do when your dividends are slashed
  3. Predicting cuts before they happen
  4. Keep a sense of perspective
  5. Don't dump equities
  6. Taking the long view

No easy solutions

"A dividend reduction is usually a flag for investors to do a bit more (research)," says Richard Hisey, president of AARP Financial in Tewksbury, Mass. "Just because somebody cuts the dividend, (it) doesn't automatically draw you to one conclusion or another. The reduction could be a sign of danger or a very prudent move."

Dividends are a company's way of sharing profits with shareholders. Some companies have big dividends because they have extra cash to pass along. Other companies have small or no dividends because they don't have extra cash or need to keep all the cash they can to grow the business.

"It's not wise to use current dividends as a guide to the company's financial health," says Joseph J. Virostek Jr., vice president of investment operations at BPU Investment Management in Pittsburgh.

When companies reduce dividends, it merely represents a change in fiscal policy. They suddenly need to hold on to capital. It's worth asking why, Hisey says. He says other possible reasons include:

  • They're investing more in building plants, developing new products or acquiring competitors.
  • They're facing extraordinary expenses, perhaps from having borrowed too much.
  • They're struggling with declining earnings and/or a plunging stock price.

What to do when your dividends are slashed

If a company trims its dividend, here's the first thing you should do: Look at the press release that announced the reduction. It's normally posted on the Internet. If you can't find it, your broker or the company's investor relations office should be able to supply it.

Try to understand exactly why the cut was made. Does management explain the reasons in a way that makes sense? Does it have cash problems, and are they long-term or temporary?

Second, examine the company's balance sheet and quarterly earnings and cash-flow filings. They, too, can be found online or by calling your broker or investor relations. On the Internet, you can go to Yahoo's finance site, type in the company's stock symbol and click on "Key Statistics."

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You also can go to the corporate filings page of the U.S. Securities and Exchange Commission Web site.

In either location, you need to assess the level of debt versus the cash on hand. If long-term debt is less than half the capital, that's generally good, says Scott Schluederberg, who manages the diversified high-yield dividend portfolio at Hardesty Capital Management in Baltimore. If it's not, the company may be in danger.

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