Market Minute from BlackRock Fundamental Equity

The outlook for dividends in the U.S.

Jul 28, 2020

Are dividend cuts set to soar as companies contend with the stress of coronavirus-related losses? Equity income investor Tony DeSpirito has a fairly sanguine view and says not all dividends are created equal.

The financial stress imposed by the global coronavirus pandemic has prompted speculation of companies having to reduce or eliminate their dividend payments to preserve operating capital. While some dividend cuts are inevitable, as in every recession before, there is reason to believe the dire projections may be overdone.

Breaking down dividend cuts

At its trough, the futures market was pricing in a 35% cut in 2020 S&P 500 dividends. This would have the index’s yield drop from 2.4% to 1.6%. Even if this dismal outlook were to materialize, stocks would still be outyielding bonds today by a significant margin. The 10-year Treasury yield stood at 0.69% as of July 1.

Our research suggests there is reason for a less pessimistic view. We have found that analyst estimates for dividend cuts generally overstate the number of cutters by five times but underestimate the size of the cut among those companies that do take action. The net outcome is a less dire backdrop, but one that needs to be navigated carefully to avoid what can be significant cuts by a subset of companies.

As we discuss in Dividends in danger?, 48 companies in the S&P 500 and 99 companies in the Russell 1000 had cut their dividend though June 1 of this year. We look at operating quality and balance sheet strength as good indicators of the likelihood of dividend cuts. We use fundamental research complemented by a quantitative screen to assess our investment universe for companies at risk of cutting their dividends. Since 1980, our model has tagged roughly 75% of dividend cutters as “high risk” in the months leading up to the cut. This is critical, because the stock price tends to decline ahead of the dividend cut, as shown in the chart below. Selling after the cut, as many investors do, can be a mistake. During the 2008-2009 financial crisis, dividend cutters and eliminators outperformed in the 12 months following the action. The early evidence suggests this cycle could be similar on that score.

The pain precedes the cut
Performance in the months before and after dividend actions

Performance in the months before and after dividend actions

Source: BlackRock, with data from Bloomberg and Refinitiv over the period 12/31/02-12/31/19. The investment universe is the Russell 1000 Index. The chart shows excess returns by dividend action in the months before and after t = 0, which represents the month-end after the dividend cut or increase took place. Shown for illustrative purposes only. It is not possible to invest directly in an index. Past performance is not indicative of future results.

Spotting the warning signs

One thing is clear: Not all dividends are created equal. A look at dividend cutters prior to the action reveals poor profitability, lack of competitive advantage, higher leverage, weak trends and cheaper valuations. These companies also tend to be among the highest yielders, the implication being that the dividend is not only high but unsustainably so.

Where to look for dividend resilience? We focus on quality companies with a record of sustaining or growing their dividend across time. “Quality” businesses, by our definition, have higher returns on capital, strong balance sheets and positive earnings trends. Their managements have a record of sustaining or growing their dividend across time.

It is notable that there are far fewer analyst estimates of company dividends than earnings ―an average of three analysts on dividends versus 15 on earnings in any cycle. This underscores for us the importance of active management of dividend strategies, especially in the type of uncertain environment in which we find ourselves today.

June brought some good news, as a total of eight dividend cut announcements in the Russell 1000 marked a sharp decline from 41 in May. This recent slowing in cuts as the U.S. economy began to reopen could offer hope that the worst is behind us. Ultimately, however, the pace of this recovery and, in turn, the true risk of dividend cuts will be driven by the virus. We are actively on watch.

Tony DeSpirito
Tony DeSpirito
BlackRock Fundamental Active Equity Investment Team
Antonio (Tony) DeSpirito, Managing Director, is Chief Investment Officer of U.S. Fundamental Active Equity. He is also lead portfolio manager of the BlackRock Equity ...