Warning signs of a dividend cut

The history of increasing dividends gives us a good idea of the strength of a publicly traded company's business model. However, the financial crisis of 2008-2009 taught us that even a company that has raised its dividend for many years may have to cut it suddenly because of unfavorable economic conditions. In most cases, a savvy investor could have spotted warning signs that a dividend cut was imminent. Here are three indicators of an upcoming dividend cut...

I. Modification of the conditions of the activity

An abrupt or permanent change in a company's business model as a result of adverse economic conditions may lead to a reduction in the dividend. During the financial crisis, almost all companies saw their economic condition deteriorate. However, the relevant question is to what extent? Consider these two examples: 

• Gannett Co. (GCI) publishes approximately 100 daily newspapers and over 500 non-daily publications in the United States, over 200 titles in the United Kingdom, and operates 23 television stations in the United States. With the mass adoption of the Internet, traditional news agencies and newspapers are dying a slow death. After several years of declining profits, GCI cut its quarterly dividend in March 2009 from $0.40 per share to $0.04 per share. In March 2012, the company was paying $0.20 per share, half of what it was paying 3 years ago, before the dividend was cut.
• Pfizer (PFE) is a leading global pharmaceutical company. However, in February 2009, it was not "too big to fail". At that time, the company cut its quarterly dividend from 0.32 $ per share to 0.16 $ per share. After years of unsuccessful attempts to get a blockbuster approved, the company was looking for a partner with a strong pipeline of drugs. In anticipation of the proposed combination with Wyeth, PFE cut its dividend. Since then, the dividend has increased to 0.22 $ per share.

II. Dividend yield above historical and industry norms

A performance which is above average and/or higher than the industry standard indicates that there is a problem with the company. It cannot be said enough: Buying stocks solely for their yield is a serious mistake because stocks are not fixed income securities like bonds. A high yield is a sign that theThe market adapts to compensate for the higher risk associated with the business. When yields start to climb, it is time to evaluate whether the company can continue to pay its dividend or not. Thus, theGeneral Electric's (GE) performance from 2000-2007 ranged from 1.5% to 3.5%. However, in 2008 it doubled as investors lost confidence in the company, before GE cut its dividend.

III. The decrease in cash available to pay dividends

Ultimately, a company's ability to pay its dividend is determined by its cash flow, not only on its balance sheet but above all on its capacity to generate flows. All of the above companies had one thing in common: a deterioration in cash flow available to pay dividends. GCI flows thus peaked in 2004 at 1.3 billion dollars, before decrease to $742 million in 2008. Although GE's have been increasing, the company has been facing significant debt. This has in fact increased from 201 billion dollars in 2000 to 524 billion dollars in 2008. 

A look into the future