Love Them Or Hate Them, You’ve Got To Watch Dividends

Dividends seem to be falling out of favor right when they probably shouldn’t, which could foreshadow worrying times ahead for markets.

🕰 Recap

• S&P 500 companies paid out $565 billion in dividends last year, beating 2021’s record. Read our story
• Last month, tech hardware behemoth Intel followed up on disappointing annual results with a 65% cut to its dividend. Read our story
• And it was later joined by mining giant Rio Tinto, which halved its annual dividend. Read our story
• Still, there are attractive high-dividend-paying stocks out there. Read our QuickTake

✍️ Connecting The Dots

Dividends – the cold, hard cash payouts companies make to investors – are important to some investors and absolutely crucial to others. So-called income investors might rely on those payments to fund their own payouts in the case of pension funds or insurance companies. And retirees – both elderly and #FIRE-ers – might use the cash to cover everyday expenses.

But lots of investors aren’t big fans of the regular cash payouts. For one thing, dividend income attracts taxes while share buybacks – another way companies can effectively return cash to shareholders – don’t, at least for now. And for another, there’s a school of thought that companies jack up their shareholder payouts when they’ve run out of value-adding ways to use cash. High dividends, then, suggest a company’s run out of creative ways to reinvest in standalone growth or is at a loss for other attractive firms to acquire – and so maybe high payouts are just the beginning of the end of that company’s fortunes.

Wherever you land on the dividend spectrum, what’s undeniable is that they are worth paying attention to. So when stalwarts Rio Tinto and Intel slashed their dividends – the latter doing so particularly unexpectedly – and their share prices barely budged, it might’ve made you wonder if that was a sign of the kind of irrationality that has historically preceded stock market crashes.

On one hand, legendary investor Warren Buffett recently reminded everyone why he thinks share buybacks are important – and, in the US, they may matter more than dividends to lots of investors. On the other hand, between Morgan Stanley’s call for a drop in the stock market this month, the firm’s business cycle model flashing “downturn”, and five other factors weighing on stocks, investors may be ignoring dividend warning signs at their peril.

🥡 Takeaways

1. Dividend-focused investors should hunt for sustainable payers that can keep growing.

To improve your chances of avoiding dividend duds like Rio Tinto and Intel, you’ll want to seek out companies that aren’t funding their dividends by taking on debt or by sacrificing essential investments. In other words, you want dividends that are sustainable. But keep in mind that those dividends are only sustainable as long as the company’s management is willing to sustain them, so look for companies with a consistent record of maintaining those payments. And remember that the value of your shares rising – a.k.a. capital appreciation – is important too: look for companies that have “defensive” growth characteristics that mean they’ll chug along no matter what.

2. Dividend reinvestment programs help make dividends less taxing.

To partially offset the potential tax burden dividends attract, some investors prefer – if a company agrees – to use a dividend reinvestment program (DRIP). This lets shareholders forgo a cash payment in exchange for more shares in the company. They’ll still have to pay taxes as if they’d taken the cash, but they’ll also get new shares at a below-market price without fees.

🎯 Also On Our Radar

The initial public offering of a Middle Eastern oil giant’s gas business, Adnoc Gas, is picking up steam, with investor demand for the shares outstripping supply before they’ve even hit the market. The firm’s set to raise $2.5 billion, which it’ll use to boost its share of the European gas market as the continent looks to shrink its reliance on Russian energy.