News & Our Thinking

Join us for a new Argent video update and commentary from our chairman, Steve Finerty. In this week’s update, we examine how dividends will be impacted by the Coronavirus.

“Don’t Worry About the World Ending Today,
It is Already Tomorrow in Australia.”

We thought we would provide a few updated stock market comments. Since our last commentary two weeks ago the stock market continues to be resilient – still obviously down for the year, but perhaps doing better than might be expected given the virtual shutdown of most economic activity over the past six weeks. While the long-term consequences of actions taken by the Fed and Congress to stabilize things are open to debate, in the short-term they have restored confidence in the bond markets. This is really important, and has given hope that U.S. businesses may be able to survive long enough to get back to a prosperous future. Be assured, we don’t want to sound like some Pollyanna who believes all our fears should be behind us – far from it – but we are encouraged that as we slowly reopen for business the length of time to recovery may be shorter than we thought a few weeks ago.

Many of the questions we hear lately from clients concern dividends – specifically, are they “safe” and how might they be impacted as the year progresses?

Personally, I have always liked it when a company implements a regular dividend-paying philosophy. There are lots of studies showing that dividend-paying companies, on average, have better long-term performance than non-dividend payers. There are exceptions, of course – think Amazon or Alphabet – but as a general rule it is a sound one. In addition, the real beauty of dividends is that in most years they, on average, increase. If one looks to the S&P 500® Index, the proxy for large U.S. companies, dividends have increased over the past 60 years at an average annual rate of 6% per year.

Of course, there are years when many dividends are cut, and this will be one of those years. In general, the tech and consumer industries are doing fine, but companies in the restaurant, hotel, auto and energy industries will have awful years, struggling to stay alive. It is an even worse situation for these companies than the 2008-2009 financial crisis.

While this will be one of the bad years for dividends, keep in mind that most companies work very hard to sustain their payouts. There are actually two ways in which companies provide direct returns to shareholders. First, they use some of their excess cash to routinely buy back shares of their stock in the open market. That is of benefit to shareholders because by doing that a company is reducing the number of shares in the market when it repurchases its own stock. For example, would it be better to own 100 shares of a company out of a total of 1,000 shares, or to own 100 shares out of a total of 900 shares? Simple math reflects that 100 shares out of a total of 1000 shares are a 10% interest in the company. Ownership of 100 shares out of 900, assuming the company has repurchased 100 shares, is an 11.1% interest – same company, just a bigger ownership stake.

The second way to provide an immediate return to shareholders is to pay a dividend, usually on a quarterly basis. When we look to buy stocks that pay dividends, we want solid investments that can withstand even the worst of news. No one can always get everything exactly right, but what our analysts study to help them get it right are particular characteristics which historically have given investors the best odds of success. What characteristics?

• We study the quality of the business, usually trying to avoid most industries that can become distressed in recessions, like auto and hotel stocks.
• We look at the strength of the balance sheet and a company’s cash flow – how much debt is a company carrying? Do they generate enough cash flow that even if for tax purposes they might be less profitable, the dividend can be supported through the lean years?
• What is the pay-out ratio? A pay-out ratio compares the amount of dividends to be paid relative to the total net income of the company. If a company is paying out close to 100% of its net income, and some do, that is a red flag.  We want to see sufficient money being retained for a rainy day.

At Argent, the average pay-out ratio in our Dividend Select strategy (which focuses on higher than average dividend-paying companies) is only 45%. This gives our average company good potential for sustaining and growing their dividend annually.

Industries and companies where we currently find solid characteristics include:

• Pharmaceuticals, where names like Abbvie, Gilead and Bristol-Myers average a 4.0% yield.
• In the cell tower industry we own a real estate investment trust name Crown Castle, with a 3.0% yield.
• In the household goods industry we own Proctor and Gamble, which has a 2.7% yield.
• Among food products, quality names like PepsiCo and General Mills generate an average dividend yield of 2.9%.
• And in tech, where our investments only have an average yield of 1.6%, we project excellent potential for dividend increases in addition to market appreciation potential. Tech names we invest in currently include Intel, Microsoft, Marvel, Skyworks and Oracle.

As things look today, it appears maybe 21 companies within the S&P 500 Index will reduce their dividend in the second quarter, with around half of those suspending their dividend in full.  The others will simply reduce the pay-out by some amount. The last time we had significant dividend reductions, in 2008-2009, close to 100 companies either suspended their dividend or lowered it by some amount. Interestingly, the vast majority were able to sustain their dividends in 2008-2009. Some even increased them. By 2011, over 150 S&P 500 companies had begun increasing their dividends again, a trend which continued until this quarter. We certainly hope that is what happens this time.

Charles Schultz, the creative genius behind the Peanuts comic strip, famously said, “Don’t worry about the world ending today, it is already tomorrow in Australia.” I think about that statement almost daily because it is actually pretty profound. Every day that passes is a day we are closer to a treatment and ultimately a cure for COVID-19. With the exception of the Great Depression, in every other such calamity world markets have faced over the past two hundred years, life returned to normal relatively quickly – not necessarily the exact same normal, but a very good life nonetheless. Simply impossible problems were resolved – and so it will be with this also. In the meantime, it is nice to know that the vast majority of our dividend-paying stocks should continue to provide important cash flow and stability for our investment portfolios. Stay healthy.

Disclaimer: Performance returns cited represent past performance, which does not guarantee future results. Returns assume reinvestment of dividend and interest but returns do not reflect the effect of taxes and/or fees that an investment would incur. References to specific company securities should not be construed as investment advice. Not all Argent clients may own each company’s stock discussed. Argent portfolio managers may recommend the purchase or sale of these and other securities for their client’s accounts.  A list of all stocks recommended by Argent during the past year is available upon request.  Some data represented in this article is derived from non-affiliated sources Argent deems reliable. However, Argent does not perform any independent research to determine the accuracy of such information.  Please visit our compliance page for additional details and disclaimers.