#1: Dividend Cutters (and Misers)
Everyone is hungry for yield these days in the form of dividends, and with good reason. The market is volatile and 10-year Treasury bonds yield a painfully low 1.6%.
But when those dividends aren’t as big as you expect, it can really hurt your holdings.
The dividend cutter many investors remember most is General Electric (NYSE:GE). The industrial conglomerate slashed its payday from 31 cents a quarter to 10 cents a quarter in 2009 — a 68% slash in dividends that has not been replaced. InvestorPlace author Jim Woods recently compiled a more recent list of 17 dividend disappointments of 2012, including KB Home (NYSE:KBH) and Noble Energy (NYSE:NE).
Other dividend cutters who aren’t as well publicized are companies where volatile payments are common and thus not as noteworthy. These often are players in the mREIT space like Annaly Capital (NYSE:NLY), which has seen its payout slump 75 cents quarterly in 2009 to 55 cents now, or shipping stocks like Frontline (NYSE:FRO), which paid a peak dividend of $3 in 2008 and just 2 cents last September before killing payments altogether.
How do you protect your income? For starters, make sure you examine the distribution history of a stock carefully before even investing. And once you’re in, pay attention to cash flows and earnings history to prevent having your pocket picked by these dividend cutters. I recommend a simple calculation involving the dividend payout ratio. In short, if a company starts to pay out significantly more in dividends than it does in earnings per share, warning bells should go off. After all, how can stock afford a $2.50 annual dividend per share when its earnings are only $1.50? The math just doesn’t work — and a cut could be looming.
As for dividend misers, the earnings history and dividend payout ratio are equally important. If a company is throwing off profits significantly higher than their dividend, you have to wonder what they are doing with that cash if they’re not paying you. A small-cap growth stock has a good excuse for paying only 10% of its earnings back to shareholders via dividends — or even not having a dividend at all — if management is investing in growth. But a large-cap stock that’s hoarding cash — I’m looking at you, Google (NASDAQ:GOOG) — for no reason isn’t giving you the value you deserve.