In early March 2009 I published my S&P 500 dividend payment estimate for 2009 at $21.97, down 22.6% from the actual $28.39 in 2008. Year-to-date, there have been 225 dividend changes in the S&P 500, equating to $57.6 billion in increases and decreases. Well, judgment day has arrived, and the estimate needs to be revised. I am increasing the 2009 full year S&P 500 payment 1.5%, from $21.97 to $22.31; I can only hope (at least from an analytical basis) that my 2010 estimate is as close. While the 2009 payment is down 21.4% or $52.6 billion from 2008, I am sure someone will say ‘that dividends beat expectations’, but be advised, telling that to a dividend investor could be hazardous to your health.
2009: The Year Of The Cut - specifically 21.4%, or $52.6 billion
2009 began where the post Lehman crunch ended. From September 2008 through year-end 2008, a record breaking $23.4 billion in dividends were cut by S&P 500 issues ($20.8 billion from Financials), resulting in the worst year for the index historically, with $40.6 billion in cuts ($37 billion from Financials). That record however was short lived. For the first three months of 2009, an additional $42 billion in dividends were cut (with $23.9 billion from Financials, General Electric cutting $8.9 billion, and Pfizer cutting $4.3 billion), setting a new annual record for cuts in just three months. Given the long-term dividend growth rate of 5.56%, even above par increases will take years to make back what has been lost.
Unlike 2008, where most of the damage was done at year-end, permitting the index to post a slight increase in actual payments, the cumulative impact from 2008 added to the devastating Q1,’09 created the worst year in dollar cuts, $52.6 billion, and is second in percentage drop, 21.4%, only to the 38.6% decline of 1938.
At the start of 2009, Financials represented 20.5% of all dividend income in the S&P 500, down from the sector’s peak of 30%; currently they represent 9.0%. While Financials cuts remained the dominant player, dividend cuts were posted across sector lines – with the exception of Consumer Staples. Year-to-date 33 of the 34 actions in Consumer Staples were positive (Supervalu reduced in October), as the sector became the leading and most consistent payer of dividends, representing 17.4% of the payments. The record speaks to earnings and cash flow, both of which were less severely hurt (on the sector level) when compared to other groups, and is reflective in the fact that their price is currently 4.0% off the October 2007 high (the best of any sector), and up 2.0% including dividends.
The most telling statistics are that the number of increases decreased 47.8% for 2009 over 2007 (from 273 to 143 for YTD November), while decreases increased 609% (from 11 to 78). For the year, 198 issues are expected to pay more in 2009 than 2008, partially due to the fact that many increased in mid-2008; 2010 will not have the advantage. Last year 224 issues paid more than in 2007, and in 2007 304 issues paid more than in 2006 (the average for the past 20 years is 271).
2010: A 6.1% Pay Raise, But Still 16.6% Less than 2008
The current stats all point to fewer and less severe decreases, partially because all the big companies have already cut (Bank of America cut $12.1 billion in dividends, Citigroup $11.5B, General Electric $8.9 billion, JP Morgan and Wells Fargo $4.9 billion each, Pfizer $4.3 billion). The current top payers, AT&T ($9.7 billion rate), Exxon ($8.1 billion), Chevron ($5.5 billion), Johnson & Johnson ($5.4 billion) and Verizon ($5.4 billion), are slightly (but not enough) more diversified than the previous top payers, where Financials dominated and made up over 30% of the dividend income (they now account for 9%). More to the point, the top five payers are all expected to earn more than they pay out in 2010, with the aggregate Operating Earnings coverage 2.28 times that of their current dividend, with a more relaxed yield of 3.58%. Balance sheets are in much better condition (Q3 set another record high for cash levels, but Q4 is expected to decrease), and debt levels (on aggregate) are manageable with 2010 not facing large maturities. Earnings are expected to increase with higher margins (due mostly to cost cutting), assisting what could be a slower sales and jobs recovery rate. Not to say that everything is good, even if the economy cooperates. Within the S&P 500, 31 issues (representing 2.9% of the current dividend payments) are not expected (on an operating basis) to earn as much in 2010 as their current dividend rate, with 14 of those 31 not expected to make enough in 2011 as they are paying (thought everything was suppose to be great by 2011, or was that 2012?). For these issues the question has to be asked, how long can they continue to put their hand in their pocket to pay holders (and I’m a dividend person).
However, with all that, the overall view for 2010 dividends is positive. While I expect decreases, I believe that improving economic conditions (which includes both the perception of unemployment and the actual numbers, with last Friday at best being a beginning and at worst a fluke) will foster companies to increase their payouts. I expect rate increases to average in the low single digits, as companies measure their forward commitment (cash flow), with the second half of the year much better than the first half, since companies will need time to reassure themselves of their product and financial position. The majority of damage for 2009 was done in the first quarter, when $42 billion of the $48 billion of cuts occurred. This will make some comparisons appear better for Q1,’10, but after the earnings ride, we should be able to recognize and get around that; February is traditionally the busiest month for increases (fiscal is over, the annual/10K is going out, and shareholder meetings are coming). The initial 2010 S&P 500 dividend estimate is set at $23.67, a 6.1% gain over the $22.31 2009 estimate, but 16.6% less the $28.39 paid in 2008. My optimistic outlook, contingent on not testing the November / December 1982 record 10.8% high unemployment level and a modest increase in consumer and corporate expenditures (an accelerated depreciation bill would help), is $24.30, or 8.9%. On the pessimistic side, more unemployment, stimulus type spending, and government programs to assist corporations would reduce my base estimate to $17.91, but under that scenario, dividends might be the least of our problems.
Beyond The Yield, Tax Preferences, and Growth - A Reason To Believe
While yields appear low (1.70% for the index, 2.36% for the 360 paying issues) compared to historical averages (3.80% from 1935) the relative comparisons are not. Five-year Treasuries yield 2.24%, 10-year is 3.48% and 30-year is 4.41%, with mortgage rates low (only charge cards appear to on the historically high side). Currently, it appears (and predicting politics makes predicting the market look easy) that the dividend tax advantage will be permitted to expire at the end of 2010 (inheritance that goes to zero next year is still being ‘discussed’). While several plans have been discussed, the general belief is that tax rates (which may be called surcharges, accelerated phase-out, special purpose, etc) in general will increase, with dividends losing their 15% maximum rate, but potentially getting some preferential treatment. The current use of fixed income instruments for fixed income retirees is also being tested now. Given the prevailing belief that rates will rise, which will cause bond prices to decline, their attractiveness is limited. Even if a retiree is able (longevity and liquidity) to hold the issue until maturity, the income (that was set prior to the increased rates) will be less than the prevailing ones. The trade-off between the two is that dividends are at the discretion of the company, while bond interest is a requirement, with stringent penalties for anything less than the timely payment of interest and principal.
Still, given the risk-reward trade off, dividends offer the lure of current income, and hopefully longer-term appreciation, or at this point in the recovery cycle, the ability to participate in the equity markets (although I still have concerns over the 63.5% post March 9th gain without a significant pullback). Over the past two years major institutions have cut their dividends to insure liquidity. Most companies have become cautious of capital commitment for dividends since once started or increased there can be a significant market penalty for their reduction. For short-term investors dividends get in the way, which is why dividends remain for long-term investors whose time line spans years and decades. Over time dividend stocks do better, and from 1926 they account for 40% of the total return. They have a lower Beta with the dividend, to some extent, acting like an anchor, reducing the gains in good times (during the late 1990s you only wanted to be in large-cap Tech), but also reducing the damage in bad times (when the 2000-2 bear market came, you couldn’t run away from those high-caps Techs fast enough).
The basics for picking a dividend issue are just that, basics. Since dividends are long-term you need to pick an issue that you feel comfortable with for the long term. One that is currently generating sufficient cash flow from current operations to cover the business operations, dividends and have enough left over for growth. I have a monthly posting on the www.standardandpoors.com of screened issues it calls a starting place. It is in no way a buy list, but a screen of issues in the S&P 1500 that have increased their dividends for at least the last 10 years (willingness to pay), and have earned enough (and are at this point expected to continue to earn them based on estimates) to comfortably cover their payments.
The damage done to dividends over the past two years will take years to recover. Given the long-term dividend growth rate of 5.56%, even above par increases will take years to make back what has been lost. It is important for dividend investors to realize that, and to evaluate their current and potential holdings in that light. Everything has risk, and there are no guarantees. Investors need to know not only what they are investing in, but also what their specific situation is - liquidity, longevity, risk tolerance. We all want higher rewards, but the risk, with its financial implications for wealth and day-to-day living, needs to be measured and understood.