Avoid Those Rose-Colored Dividends
Interestingly, 4 percent of the companies paid no dividend in 2007 but had initiated a dividend by
2009. In the middle of the worst financial crisis since the great depression these companies decided
to initiate a dividend that dividend proponents might interpret as a sign of strength in the face of
adversity. Unfortunately, investors didnít see it that way, and these companies actually delivered
worse TSR than the general market, with a median of negative 69 percent.
For perspective, consider that an investment of $1,000 in the median company initiating a dividend
by 2009 would have been worth $310, which is 34 percent lower than the $470 for the broad market.
Those initiating dividends actually destroyed substantially more value during this period!
The worst performer was AIG. But fully 80 percent of these companies underperformed the market
median. Why did these companies perform so poorly? In many cases it seems they may have been
trying to compensate for poor performance with the good news of initiating a dividend. Investors
seem to have seen right through the ďspinĒ of their dividend initiation and focused on the weak
performance. Donít try to prop up perceptions during tough times with a rose-colored dividend.
How about companies that had a dividend in 2007 but eliminated it by 2009? About 3 percent of
companies eliminated their dividend. Their median TSR was negative 52 percent - almost the same as
the broad market. How could companies eliminating their dividend fair the same as others? It seems
investors saw the action as prudent given the magnitude of the financial crisis. If cutting the
dividend is the correct course of action to protect the companyís cash flow during difficult times,
donít be afraid to do it.
The majority of companies had a dividend in 2007 and in 2009, and these companies delivered median
TSR of -49 percent, a bit better than the market overall. Those that reduced their dividend had
worse TSR than those that increased their dividend, as would be expected. But among those that
increased the dividend, those increasing by more than 25 percent did worse than those increasing
less than 25 percent. Perhaps some of the larger increases were perceived similarly to the dividend
initiators, and that may have influenced this negative outcome.
So what does this all mean for dividend policy? The following are some guidelines for dividend policy
during the next stock market and economic downturn:
- Dividends are important, but underlying performance is more important. Donít try to compensate for
weak performance by overdoing the dividend, as investors are likely to see right through it.
- If the financial condition of a company declines so much that the best course of action is to
conserve cash by eliminating the dividend, seriously consider eliminating it. This is never a nice
situation to face, but if it is in the best interest of the company, the act of cutting the dividend is
unlikely to cause any further decline in share price than would otherwise have occurred.
- In advance of the next downturn, be prudent with leverage and protect cash flow. Try to avoid
having to take drastic action on dividends and other discretionary cash flow items in the next
Every company faces a different situation. But hopefully these suggestions will help companies make
better decisions and weather the next market storm.