Dividend cuts: last resort not a first thought
Once companies did anything to avoid cutting dividends. In 2009 it is the most fashionable thing to do but directors should be careful they do not become fashion victims.
A recession is no reason to reduce the return to shareholders. Yet this year investors are lucky if their company freezes their payment; many so-called blue chips are cutting or abolishing dividends entirely.
When cost cuts are being made elsewhere, including investors may seem fair. Certainly companies that are laying-off labour find it easier when they can say the providers of capital are sharing the pain. But companies are supposed to maintain revenue reserves so that they can keep paying dividends during depressed times.
They typically pay out only 40 per cent of profits in the goods years so that there will be something for the rainy days. Why isn’t that reserve being used now?
Using reserves like a with-profits fund to smooth returns allowed good companies to maintain unblemished records of rising dividends but in 2009, those reputations are being lost.
New managements like to announce large write-offs and losses to set a new base so that even returning half-way to past performance looks like an improvement. It is dangerous to do that with dividends, however.
Investors like the long-term record of strong returns. They are aware that stockmarkets can savage share prices but dividends remain in the remit of directors. And with the other fashion of 2009 being directors turning to shareholders for new capital through rights issues, why should investors buy shares from companies that cavalierly cut the return?
Directors devise lots of excuses for cutting dividends but the worst is that the shares are yielding more than the market. Certainly, if a share price halves, the yield doubles when dividends are maintained, but using that as a justification to halve the dividend to restore the old yield add insult to injury. It means investors who have lost half their capital will now lose half their income too.
Adjusting dividends to cut the yield to market levels suggests directors are interested only in attracting new investors and have no interest in existing owners. They ignore their loyal shareholders at their peril.
