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In the Market - February 2009
Feb 15, 2009
Dividends at Risk
With the pummeling the stock market has taken over the last 6 months dividend yields are at an all time high. While dividend investors may be excited about yields approaching and surpassing 10%, even from these levels it’s not all roses. While more companies have raised their dividends this year than have cut them, dividends are at risk. For many companies, keeping their dividend or increasing it is a priority. However, with earnings falling and cash disappearing, companies will have to borrow money to finance their dividends or face the prospect of cutting their dividends. We’ve seen it already with financial companies since they have taken the first big hit. As the economic downturn continues to affect companies in other sectors we expect more dividends to be cut.
Aside from the price change associated with a dividend change, volatility changes as well. Taking a look at the Dow 30, practically every company has had corporate actions in the last few years either raising or cutting their dividends. We looked at the short term risk and performance of these companies for the 30 days prior to the announcement of the corporate action and post the announcement. The results clearly indicated an over 17% rise in the risk after the corporate action is announced. The risk is calculated off the Dow Jones Industrial average as a benchmark. The returns of these companies for the 30 days post the corporate action announcement is over 33% lower than the Dow Jones.
The chart below takes a year by year look at each dividend announcement for a Dow 30 stock. The chart shows the volatility of each stock relative to the Dow Jones volatility. We do this to strip out the market factor. Dividend cuts might be best for the long term health of a company in the current economic conditions, but risk and return associated with dividend changes don’t paint a bullish picture.