Avoiding Companies That Might Cut Their Dividend

With short-term interest rates near 0%, it is enticing to buy high yielding dividend stocks and just sit back and watch the dividend checks roll in. But it is very important that investors understand that when times get tough, companies that can’t afford their dividend any more will cut it; and some will slash their dividends immensely.

It is not commonly known that during the Great Depression, the average Dow Industrials dividend yield peaked at slightly above 12% and then quickly fell to almost 3%. Those who invested for income at the dividend yield peak would have seen their dividend income fall by nearly 75%. What is also not commonly known is that not every company during the Great Depression cuts its dividend. IBM, AT&T, and Exxon kept their dividend payments relatively stable.

So how do we find great companies that will increase their dividends consistently during stable times and have a good chance of holding their dividend steady, even in a serious downturn? I believe the answer to this question lies in looking at the company’s dividend growth history, payout ratio, and how the company fared during the last downturn in 2008 and 2009.

What we are looking for are companies that have a long history of consistent dividend growth, even in recessions, a low payout ratio, which means they can more easily service their dividends with their income, and the ability to ride out the most recent recession without cutting dividends or seeing earnings fall too drastically.

Let’s take a look at a company that has all the right metrics when it comes to predicting how it will do in a serious economic downturn:

It almost seems too good to be true, but Coca-Cola didn’t just maintain its dividend during the last recession, they increased it by 21%. It wasn’t too difficult to do given that their earnings per share (EPS) climbed an astounding 54% during that time. Also of interest is the fact that the company has not cut its dividend in over 40 years. Clearly Coca-Cola is not nearly as tied to the fortunes of the overall U.S. economy as many companies are.

I plugged in the dividend numbers into our free calculator called Total Returns- Dividends vs. Price Appreciation, and calculated that if you would have bought Coca-Cola five years ago you would have earned 3.1% per year solely due to the dividend payments. That is not too bad considering how awful economic growth has been the past five years.

Great companies that investors can hold for a lifetime are out there. The more confident investors are in their companies not cutting dividends in a downturn, the more likely they are to hold tight and not hit the panic button if and when we enter another recession.