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The policy interest rate from the Bank of Canada is sitting at 0.25%, a full 150 basis points lower than it was at the start of the month. Income-seeking investors are likely now more than ever seeking out cash-generation through equity exposure versus long term fixed income investments. For reference, the 10 year government of Canada benchmark bond is yielding just 0.72% yield, while the S&P/TSX Composite Index has a an expected yield of 4.3%. Remember that the yield on the index was just 3% at the end of last year prior to COVID-19, attributed to the deep cuts in stock prices.
There is no foolproof way to tell in advance if a company is going to announce a dividend cut, especially in an uncertain economy. But there are things that investors can look for to provide a bit of certainty:
Payout ratios
A payout ratio is calculated by dividing the distribution (either paid or expected to be paid) by earnings or cash flow (either on a trailing basis or using estimates from the street). For example, if you had a company that reported an earnings per share of $1.00, and paid a dividend per share of $0.50, the payout ratio on earnings would be 50%. If a company has an earnings per share of $1.00, and pays out $1.50 worth of dividends, the payout ratio is 150%. This implies that the company is paying out more than it is earning, a practice that isn’t sustainable in the long run. This often happens because investors prefer a consistent dividend over time, and management generally tries to comply. However, earnings are not consistent. A company may temporarily have to pay out more than they make in a given fiscal quarter to avoid having to make a dividend cut. Income-seeking investors should seek companies that have conservative (i.e. lower) payout ratios if possible. In general, payout ratios for utilities, energy, and REITs are best calculated using the company’s cash flow from operations. For all other sectors, an earnings-based calculation can be appropriate. It would serve investors well when looking at companies with extremely high yields to calculate this ratio to understand whether that yield is sustainable in the long run.
Historical dividend payments
It takes fiscal responsibility to be able to pay a consistent or increasing dividend over time. Looking through the trend of dividends payments for a company can offer insights into when they raise or decrease dividends. It is not surprising that may longstanding Canadian firms have a history of keeping distributions steady. It might also be worthwhile to look at how the company’s distributions changed during the 2008 financial crisis, or during the oil crunch of 2014. Companies that have a policy to try to increase dividends over time may be more desirable than companies that pay a high but unsustainable yield.
Company guidance
Most large Canadian companies will provide guidance to investors on their plans with dividend distributions for the upcoming quarter if not for farther into the future. Although guidance can quickly change especially during uncertain times, keeping on top of company announcements will allow investors to understand the company’s general direction and perhaps reasoning behind why a dividend cut is necessary.
Remember that a public company’s management has control over the amount and frequency of dividend distributions. Fiscally responsible companies will keep a balance between paying distributions to investors, and ensuring they have enough capital to fuel continued operations and future growth. As a starting point for more research, here is a list of dividend-paying companies that have met the following requirements:
- Have a dividend payout ratio on expected earnings and expected cashflow of less than 80% and 60%, respectively
- Have not cut their dividends since the year 2000
- Have not announced yet that they will cut dividends in the upcoming quarter (expressed below as the expected dividend growth rate, figure must be 0 or greater).
- A yield greater than one per cent.
This article does not constitute financial advice. It is always recommended to speak with a financial advisor or investment professional before investing.
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