Monday, April 6, 2015

An Early Warning To U.S. Stock Market Investors: Dividend Payments Can Be Cut

One of the bullish arguments for U.S. stocks I hear constantly is that dividend payments for many companies are higher than the return you can receive on a treasury bond out to 30 years. Dividend payments, we are told, are raised every year so your income will continue to rise with inflation in the years ahead.

What is never mentioned during these discussions, which usually takes place when companies are trying to convince individuals to have their savings managed with an annual fee by their organization, is dividend payments can also be cut. Unlike bonds, when the economy turns down dividend payment cuts are one of the first tools companies use as they search for a way to save or locate desperately needed cash.

Last month the number of public companies cutting their dividend reached 56, a spike exceeded only by the financial crisis and fiscal cliff drama. This is due in large part to the collapse in oil prices because many companies are scrambling to find ways to save cash.



This is not to say that bonds will perform better than stocks over a particular period. I only mention it so you can have both perspectives when making an investment decision after hearing a sales pitch that says "dividends will continue to rise and keep pace with inflation." Nothing hurts worse than a collapsing stock price at a time your dividend payments are being cut.

I believe this is coming soon for many U.S. companies that have borrowed an excessive amount of money to re-purchase their own shares. A corporate executive's goal is to make their organization's balance sheet look as strong as possible the next quarter. Right now that can be accomplished by taking on debt to purchase shares due to today's anomalous low interest rates. If they do not make this decision to boost their share price in the short term, as other executives are doing just that at other companies around them, they will lose their jobs.

An executive's job is to think of what's best for their organization and juice profits quarter by quarter. Your job as an investor is to see the forest from the trees and determine what is best for your portfolio over five years or more. When the tide goes out and these U.S. companies are holding a huge pool of their own shares as they collapse in price, with a large pool of borrowed money used to buy those shares, it will be clear who was actually swimming naked. We have been told relentlessly these companies own a record amount of cash today, but when cash becomes king investors will learn they also hold a record amount of debt on the other side of the balance sheet.

For more see: The 6 Year U.S. Stock Market Rally Relative To History & What Comes Next

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