Being Diligent About Dividends
Author: Stephen Duench
May 28, 2020
The COVID-19 pandemic is creating a familiar dynamic for dividend investors who have navigated economic downturns in the past, with record-high yields on one hand and payout suspensions and cuts on the other. And just like previous crises, the fallout from the virus is a valuable reminder that dividend-paying stocks are not created equally and must be evaluated on their own merits.
To that end, there’s no question that yields across the broad spectrum of dividend payers has become more attractive relative to 10-year government bond yields in recent weeks. In Canada and the U.S., this is true across most sectors and the average spread between the two yields recently reached all-time highs, based on our data since the Second World War. At the same time, many industries are now boasting average dividend yields near or at their historical highs on an absolute basis.
Canadian Dividend Yields: Today vs. History
But higher yields are only part of the equation that makes up the current landscape for dividends. Also at play is a growing list of dividend suspensions and/or cuts as companies batten down their hatches in hopes of minimizing the damage of the economic slowdown. In many cases, these actions are being taken to shore up already diminishing balance sheet strength or to pre-empt such deterioration from happening in the first place. Meanwhile, some companies are suspending or reducing their dividends on principle after having to furlough employees unable to work due to government shutdowns and social distancing measures.
U.S. Dividend Yields: Today vs. History
Either way, this growing list highlights the value of analyzing dividend payers based not only on the size of their current yield, but also its sustainability over time. And while it’s difficult to predict whether a company chooses to suspend or cut its dividend under extraordinary circumstances, it’s possible to forecast which companies may be forced to make those same decisions. For example, those with low debt-to-equity and high cash-to-asset ratios are more likely to support their dividends than those without. The same goes for payers that have historically high return-on-equity (ROE) and low payout ratios.
Keeping close tabs on these factors—along with others such as high free cash flow yield and high free cash flow margin—should be nothing new to seasoned dividend investors, but doing so rigorously has not been this critical since the Great Financial Crisis more than a decade ago. After all, the opportunity set for dividends may never be more attractive than it is now, but it also may never be more precarious.
Stephen Duench is a Vice President and Portfolio Manager at AGF Investments Inc. He is a regular contributor to AGF Perspectives.
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