Max's Investment World Stock Market Challenge
Dividend Cuts Mean Good Things to Come
Shareholders aren't particularly thrilled when their company
lowers or eliminates its dividend. After all, many people count
on dividends to pay off current bills. Shareholders also think
that a cut in dividends is a sign that the company will perform
badly in the future and so, sell off their shares.
That's a big mistake. Researchers recently found that a company
that cuts its dividend has already experienced the worst and
is signaling to the world that it is on the road to recovery.
Professors at Northern Illinois University examined 268 companies
from 1974 to 1989. In the two years before companies cut their
dividends, earnings dropped sharply but they improved sharply
two years after the dividend cut. Stock prices of such companies
paralleled the trend of earnings.
But the companies didn't improve earnings after they cut dividends
by boosting sales. Rather, they cut costs for materials and
services in the products they sold, the professors found. While
part of the cost-cutting is healthy, companies tended to purchase
fewer fixed assets and spent less on research and development,
which could hurt their long-term competitiveness. Moreover,
these companies had difficulty cutting administrative and other
costs not associated with the products they sold and many found
it difficult to raise new capital to finance expansion.
Still, two years after a dividend drop, most companies in their
study were healthier as indicated by improved earnings, stock
price, cash positions, and lower debt.
Bottom line: if you haven't acted before a company you own stock
in cuts its dividend, it's not a good idea to sell just after
the cut is announced. Rather, investors should wait at least
a year in the belief that the company will bolster its financial
position and its stock price will improve.
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