Declining cash flow and cheap valuations might lead these two companies to cut or suspend their dividend payments causing their share prices to decline and investors to suffer heavy losses. Sell these two stocks now and reinvest those earnings elsewhere in the market.
For the dividend stock investor, an announced dividend cut by a portfolio stock will produce a double-whammy bad news effect. First, there is the loss of the expected income when a dividend rate is reduced or suspended. Second, a dividend cut announcement is almost always accompanied by a steep drop in the share price.
A quick price drop makes it difficult to sell shares and still have enough capital from the sale to reinvest that money and replace the lost dividend income. Ouch! and Ouch! While avoiding or ever experiencing a dividend reduction in your portfolio is difficult, if you know the warning signs you have a good chance to identify and sell those stocks in your account before they hit the market with dividend reduction bad news.
A company paying a steady and growing dividend is one of the best signs that management is working to manage the business for the benefit of share owners. You would be surprised at the number of companies that are managed to grow assets, which increases management compensation, without generating better returns for the investors who own shares in the company.
In a diversified income stock portfolio, you want the majority of your stocks to be companies that at least occasionally increase their dividend payments. As the saying goes, there is no safer dividend than one that has just been increased. For the stocks you own that haven’t increased their dividend in a while –say more than a year– here are the factors you need to watch that will allow you to sell before an actual dividend reduction is announced.
Declining Free Cash Flow Per Share
When a company has a long record of dividend payments without a reduction, the Board of Directors and top management are very leery of breaking that record. If business results turn down and the profits to pay dividends start to decline, the company is likely to continue to pay the current dividend while management develops plans to reverse the downturn in the company results.
However, if the business downturn is not reversed, the Board will eventually be forced to cut or suspend the dividend. This means that you will have ample warning that a dividend cut is potentially in the cards. Check
the net income or free cash flow (called funds from operations (FFO), funds available for distribution (FAD), distributable cash flow(DCF), or something similar) every quarter on each of your dividend stocks. If you see a trend of declining cash flow, be ready to sell your shares if the results do not quickly turn around.
Otherwise, you end up owning a stock like AGNC Investment Corp (Nasdaq: AGNC). This company has cut its dividend seven times in the last five years. Each cut was well telegraphed by declining net income per share.
Don’t Believe Management’s Stories
This is the corollary to the factor above. When business turns down, a company’s management will announce its new plans and programs to turn the business around. Keep in mind that this is the group that led the company into trouble in the first place, and that management always believes its own story.
When business results and profits start to decline, you must focus on the income and cash flow statements and take management comments with a very large grain of salt.
Calumet Specialty Products Partners, LP (NASDAQ: CLMT) is a stock that I regularly warned investors on in 2014 and 2015 that the company was not earning enough to support the dividend. Management kept repeating that new projects would come on line in late 2015 and 2016 and those projects would be very profitable.
In reality, several of the projects were money losers instead of cash flow generators, Calumet fired the CEO and brought in a new management team, and the dividend was suspended at the start of 2016. A company to watch now is W.P. Carey Inc. (NYSE: WPC). This REIT has lost its ability to continue to grow the dividend and management does not seem to have a valid solution to the slowing cash flow problem.
The Market May Be Right, Even When It’s Wrong
If the market thinks a company could or will cut its dividend rate, the share price will be driven down and the current yield will go much higher. If the dividend is actually secure, this can be a good buying opportunity to pick up cheap shares and lock in a higher yield. However, an extreme yield change, often coupled with an overall or sector bear market may force a Board to reduce the dividend even though they could continue the payout to shareholders.
The energy sector decline in 2015 forced this action on pipeline companies Kinder Morgan Inc. (NYSE: KMI) and Williams Companies Inc. (NYSE: WMB). Even though both were profitable enough to sustain their dividends, falling share prices drove their yields from around 4% up into the double digits. The Boards of
Directors of both companies decided that it would be
better to retain that cash in the business to pay for future growth projects and in 2016 both KMI and WMB reduced their dividend rates by about 80%.
Sunoco LP (NYSE: SUN) is in a similar situation as both KMI and WMB. It yields 12% right now and has adequate cash flow to support its dividend. However, to fund future growth projects the SUN Board may elect to conserve that cash that would go to shareowners if the market puts such a cheap value on the dividend payments.
Successful dividend investing requires a different mindset than investing in regular blue chip stocks. If you’re not paying attention to the right metrics, your income stream can disappear in a moment’s notice and without warning.
But with current income becoming so important to investors in today’s market, owning high-yield dividend stocks has become a necessity for many people. But, not all high-yield stocks are made the same and many carry huge amounts of risk to your income and principal.
To respond to these needs from investors, I have developed a unique tool called the Monthly Dividend Paycheck Calendar that can help you to start earning paychecks every month of the year.
We’ve been using it for a few years now to deliver a steady stream of monthly income for investors from safe, high-yield stocks. And unlike what the scare mongers out there offer, my Monthly Dividend Paycheck Calendar offers you a real solution whether you’re just looking for extra income or trying to make up for lost time.