The Dividend Letter: Safety in numbers
Will companies keep paying dividend during this crisis? With so much uncertainty and companies announcing dividend cuts seemingly every day, we are right to be concerned on the impact the corona-crisis will have on company pay-outs to shareholders. In this Dividend Letter we aim to assess the impact of this crisis on our dividend strategy. History is reassuring; although dividends are not immune to recessions, they are resilient.
Dividends have historically proven to be quite resistant to downturns. In the post-WW2 period the US has gone through eleven recessions and during these periods, corporate earnings fell by about one-third on average. Dividends have proven to be much more resilient; total dividends for the S&P 500 declined materially in only four out of eleven recessions and in three of these they fell by less than 10%1. Companies have good reason to keep their dividend stable: if pay-outs to shareholders were as volatile as stock prices, they would add little value for an investor. Nor would they be useful for an income-focused investment strategy.
Dividends in the financial crisis
Although dividends may be more resilient than earnings, they are by no means immune to a crisis. During the Global Financial Crisis dividends took a serious hit when they fell by 27% on aggregate, and took years to recover. That is significant and a worrying signal to investors and anyone who depends on them for income. But to put it into perspective, corporate earnings fell 92%. Adjusted for inflation they were comparable with the trough of the great depression of the 1930s2. Pay-outs to shareholders only declined to the level where they were in 2003 as cash flows were far more stable than accounting profits.
To give us an idea of what we may expect during the current crisis, we analyzed what happened to dividends during their worst period in recent history3. How did the dividend pay-out by individual companies across the world change during the GFC? It was a difficult period, but as it turns out the risks were largely offset by new opportunities.
While they may be resilient, dividends are certainly cut during a recession. But the headline numbers hide much of the underlying dynamics. At the company level there is some relief, at least for active investors. Of all dividend paying stocks, dividends were entirely scrapped or reduced for nearly 50% of all companies in the index. This is a significant number, however it implies that more than half of the companies in the index were able to maintain or increase their dividends during the worst recession since WW2.
For the high-dividend universe the results were not as reassuring4. One in five companies completely cut their dividend and another 50% of the companies paid out less than they did before the crisis. The decline looks grim, but as noted the underlying dynamics are supportive. The differentiation is already clear across sectors. On average, cyclical sectors saw more and deeper cuts in dividend pay-outs; no surprise. But defensive sectors held up surprisingly well, half of the companies in them even raised their dividend. And while 70% of all companies reduced their dividend, 60% maintained a yield above 3%. Nonetheless the dividend universe was highly dynamic. By the time the recovery set in, well over 200 new companies (40% of the total) had entered the high dividend space.
An economic crisis is a difficult environment to navigate. For investors it may at times seem impossible when one company after another announces their dividend is up for review. It is easy to forget that many companies remain which are financially resilient - resilient enough to endure a deep recession and continue to reward their shareholders. And after a market correction, those companies offer better value for money.
“History is reassuring; although dividends are not immune to recessions, they are resilient.”
Will this time be different?
How does the current crisis compare to history? As it has been so abrupt and severe in its impact, it is difficult to say at this point. Which is why we took a good look at history as a guideline. A decline in pay-outs to shareholders as severe as the aftermath of the financial crisis is not an unlikely scenario. Consensus estimates provides some preliminary insight into what we may expect from a dividend perspective. For our high dividend universe we compared per company the expectations for the next dividend to be paid out to the most recent one5. As the table below illustrates, we are right to worry; many companies expected to pay out less - or nothing - to shareholders this year. But once again, there are still many who will.
A word of caution first; consensus estimates react slowly to rapidly changing circumstances and likely do not fully reflect the impact of the global lockdown yet. Which is why we do expect the actual numbers to come in weaker than shown in this table. However, there is one reassuring signal; the dispersion at the sector and company level is very large once again - energy and financial companies are taking the worst impact. Defensive sectors live up to their name again, with the smallest average declines both in number and size. There are thus enough safe havens to weather the current storm.
However for us as active managers there is an even more interesting dynamic going on. The dividend yield is determined by two factors: dividends paid and price. We have shown dividends fall during a recession, but prices tend to decline much faster and deeper. That implies that after a market downturn, after accounting for the lower dividends to be paid out, we are actually left with more companies paying a high dividend yield. Of course not all fit our general investment criteria and some will disappear again soon as prices recover, but at the time of writing the amount of companies in the high dividend universe is 40% larger than it was at the start of the year. Reason for cautious optimism, at least for active investors.
From a business perspective the nature of this crisis is unique; entire sectors of the economy have been shut down. In sectors directly hit by the corona crisis, companies quickly announced postponement or dividend cuts to weather the storm. Many companies have not cancelled their dividend but adopted a wait-and-see approach. Although it complicates things for us, it may be the smart thing to do.
From a social perspective, the pressure on dividends is also without precedent. They are now a hot topic in light of corporate responsibility. Should companies be allowed to pay out profits to shareholders during a crisis? Those in vital industries and that largely depend on government support should preserve cash but in our opinion a healthy company that is hoarding cash benefits neither the shareholder nor society. Dividends remain a vital source of income for many consumers.
With this much uncertainty around the severity of the fallout of the global lockdown, it may be prudent to postpone paying dividends temporarily. There is some comfort in the knowledge that historically there have been enough companies that keep rewarding shareholders, even in the toughest times. Certainly, most of the pain in terms of earnings and dividends still lies ahead. However, as was the case in the previous crisis, it also brought new opportunities for our strategy. We are confident that as active investors we have enough room to navigate these challenging times!
- Based on the database U.S. Stock Markets 1871-Present and CAPE Ratio by Robert Shiller, available at http://www.econ.yale.edu/~shiller/data.htm
- Comparison for US companies only due to a lack of historic data in other regions. Based on Shiller database named in footnote 1.
All analysis for individual company dividend change is based on actual dividends paid per share as reported by companies in the MSCI world index. The comparison is done between end of December 2007 (well before the collapse of Lehman Brothers, the trigger for the GFC) and December 2009 (when the economic recovery had set in), source: FactSet
Companies with a dividend yield above 3%
Data for MSCI World index, based on actuals reported by companies and consensus estimates (as of May 18, 2020) for dividend per share, source FactSet
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