The Limit of Generosity: Stock Payout Engine Is Seizing Up

Updated on
  • Fewer dividend increases in 7 of 10 sectors in first quarter
  • Led by energy companies, dividend cuts double from last year

Relentless acceleration in U.S. dividend growth that began during the last recession is over.

The pace at which U.S. companies increased their dividends in the first quarter, historically the biggest period for dividend growth, was the slowest since 2009. While actual cuts to dividends were mostly limited to oil-related stocks, seven of 10 sectors in the Standard & Poor’s 500 Index had fewer companies increasing their payouts compared with a year ago.

Corporate dividends have played a special role in the seven-year stock rally, with the prospect of regular cash outlays drawing investors to equities from lower-yielding asset classes like bonds. Any sign that their appeal is withering could be a problem for a bull market that is already faced with the worst earnings season since the financial crisis after its longest streak yet without touching a new high.

“Energy is the poster child, but it’s up and down the line almost everywhere now,” Howard Silverblatt, an index analyst at New York-based S&P Dow Jones Indices, said by phone. “Even if companies are going to increase their dividends, they’re doing it in smaller amounts. Earnings and cash flow have both declined and uncertainty remains high and it makes it difficult to spend money.”

S&P 500 dividends grew $3.9 billion in the first quarter of 2016, about 69 percent less than they did in the same period a year ago, according to data from S&P Dow Jones Indices. In the 12-month period ending in March, dividend cuts totaled $18.7 billion, almost double from the prior year.

It’s no coincidence the slowed pace is happening as corporate earnings are expected to shrink for the fourth straight quarter. The sum of dividends and buybacks last year exceeded that of operating earnings for the first time since 2009, according to Yardeni Research Inc.

There were 114 companies that increased their payouts, compared with 130 last year. Technology and financial shares had the biggest slowdown in growth, with four fewer companies in each group raising their dividends than in 2015. Among the 10 companies that cut their dividends in the first quarter, seven were energy stocks.

Companies that offer shareholder-friendly activity in the form of dividends and stock repurchases have lured investors throughout the bull market. An S&P index tracking 50 stocks that have consistently increased dividends for at least 25 years, and another measuring the performance of those buying back the most shares, have beaten the S&P 500 by at least 48 percentage points since March 2009.

The demand for dividend-paying stocks has been on display this year as the Federal Reserve indicated it will raise interest rates more slowly than it had previously indicated. The dividend index is up 16 percent since Jan. 20, the biggest advance for any stretch that long since 2009. The gauge was up 0.3 percent at 10:14 a.m. in New York as the S&P 500 added 0.7 percent.

Throughout that time, shareholder distributions have swelled to a bigger proportion of the cash available to pay them. On an absolute basis, payouts in 2015 reached the highest ever and accounted for a larger chunk of operating earnings than any period since 1994, apart from a stretch from 2008 to 2009.

“It makes all the sense in the world you wouldn’t see much growth in dividends unless you see a big growth in earnings,” Nicholas Colas, chief market strategist at Convergex Group LLC, said by phone. “If margins are high and revenue growth isn’t there, you won’t get the type of earnings growth that would engender dividend growth.”

By some measures, the dividend growth story doesn’t look to be improving any time soon. Traders are currently betting that S&P 500 dividends will grow 1.1 percent annually for the next five years, according to an analysis of futures contracts by BNP Paribas SA.

The bank’s study is based on the price that investors pay for swaps on futures contracts that bet on the size of the aggregate S&P 500 dividend. The contract expiring in December 2021 currently trades at $46.55, compared with the benchmark’s dividend of $43.49 per share in 2015.

“If the dividend market is correctly priced than the equity market has to be expensive, it’s in contrast to current analyst expectations,” Stewart Warther, an equity and derivatives strategist at BNP in New York, said by phone. “There either has to be a massive drop in the current payout ratio for dividends, or a massive drop in expected earnings. That’s the key implication.”