No matter how long the track record, don’t fall into the trap of overvaluing a dividend for its own sake, especially if there is no future earnings growth behind it.

Investors have always loved dividend payers. Many studies have championed the stability and consistently implied by companies that pay a solid dividend. Further, many also argue that when a meaningful portion of stock’s total return is delivered by income, the experience is less volatile and, therefore, less risky.  Finally, in order to pay a dividend, a company needs to have a certain scale and confidence that a payout can be sustained, i.e. often larger, “blue-chip” companies with well-known brands.  Indeed, tech giants META and GOOGL recently capitulated to Wall Street pressure and joined their MAG7 compatriots APPL and MSFT in paying a dividend (albeit small relative to their free cash flow generation).  Now, they too can call themselves part of the club.

Don’t get us wrong, we love the dividend growers like the ones in our Rising Dividend strategy.  Because these pay  reasonable yields through growing earnings that translate into significant free cash flow while simultaneously re-investing in future growth, all without substantially increasing total debt burden.

But there are those companies of blue chip royalty who can’t support their dividend through organic cash flow generation. They resort to other gimmicks to live up to an ever-increasing payout demand, such as:

  • Borrowing to make the payout — When interest rates were virtually zero, this wasn’t necessarily a bad decision in and of itself.  Now that capital has a real cost again, borrowing at 5-7% to maintain a 2-3% dividend yield seems unsustainable.
  • Or worse yet, they defund growth — Diverting precious resources that could ultimately fuel growth and create a sustainable outcome to maintain the charade.  This can create a downward spiral that leads to an eventual dividend cut, typically followed by a significant decline in stock price, either immediately or over time.

Some recent examples are:

  • Leggett & Platt slashed its dividend by 89% (4/30/24) — Previous “dividend king” and “dividend aristocrat.”  Had increased the dividend for 52 consecutive years.
  • 3M lowered its payout by 33% to 40% of FCF (4/30/24) — Previous “dividend king” and “dividend aristocrat.”  Had paid a dividend for over 100 years and had increased the dividend for 64 consecutive years.
  • Walgreens cut its dividend by 48% (1/4/24) — Previous “dividend king” and “dividend aristocrat.”  Had increased the dividend for 50 consecutive years.
  • Intel slashed its dividend by 66% (2/22/23) — Had never previously cut its dividend but froze it in 2014.
  • AT&T cut its dividend by roughly 50% (2/4/22) — Previous “dividend aristocrat.”  Had increased the dividend for 35 consecutive years.

Apparently, being a “royal” isn’t what it used to be (I’m sure Prince Harry would concur with that statement).  In these and similar cases, a company continues to increase its dividend, perhaps in an effort to mask or draw attention away from deteriorating fundamentals.  Alternatively, perhaps to appeal to an investor base that has an inflated view of the value of a dividend or a “royal” title.  For those willing to look under the hood, it’s the equivalent of putting “lipstick on a pig.”

This is typically when analysts jump in to call the turn–announcing that the stock is a “buy” –reinforcing that the dividend cut was “necessary” to “clear the decks” or “reset expectations” for future success.  After all, could it get much worse?

We are believers in what is possible going forward and somewhat agree that what happened in the past may not matter.  Why not avoid the roller-coaster ride along the way, or at least understand the ride you’re on?

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Sources: Bloomberg, Validus Research

The Validus Global Growth strategy, Inflection Universe and the Destra Multi-Alternative Fund (DMAF) that is sub-advised by Validus invest in META. The Validus Rising Dividend strategy invests in MSFT. Securities highlighted or discussed in this blog have been selected to illustrate Validus’s investment approach and/or market outlook and are not intended to represent any strategy or portfolio performance or be an indicator for how strategy or portfolio have performed or may perform in the future. Each security discussed in this blog has been selected solely for this purpose and has not been selected on the basis of performance or any performance-related criteria. The securities discussed herein do not represent an entire portfolio and, in aggregate, may only represent a small percentage of a strategy or portfolio holdings. The strategies and portfolios are actively managed, and securities discussed in this blog may or may not be held in such strategies or portfolios at any given time. These individual securities do not represent all the securities purchased, sold, or recommended and the reader should not assume that investments in the securities identified and discussed were or will be profitable. Nothing in this blog shall constitute a recommendation or endorsement to buy or sell any security or other financial instrument referenced in this letter.

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