“Oftentimes you’ll get a concentration in a strategy of financials, or telecommunications, or some sector or subset of companies with higher dividend yields because they’re experiencing financial difficulty,” says Colyer. “These companies end up in the situation where they’re not earning the money it would take to continue to pay the dividend. Most recently, that was GE.”
General Electric’s recent decision to cut its dividend in half should stand as a warning to investors relying on equity yield for income. Despite its financial distress, GE was growing its dividend through 2016.
During the financial crisis, several bank stocks suspended or cut their dividends in a short amount of time. In the collapse of energy prices from 2013 through 2015, many oil and gas companies were also forced to reduce or freeze their dividends.
Companies are pressured by their public ownership to keep share prices high, but steep price declines often accompany dividend cuts. Thus, companies have little incentive to adjust their dividend policies in a timely manner. It’s become more commonplace for companies to take on debt to continue their dividends.
Jane Shoemake, a client portfolio manager on the Global Equity Income team at Janus Henderson Investors, says that Janus has actively limited its exposures to utility stocks since many companies in the sector suffer from slowing levels of growth, regulatory pressure and possible disruption from technology.
“I’m concerned about disruption, as renewable energy, electric vehicles and other technology puts pressure on traditional companies,” says Shoemake. “Taking a beater passive approach is not the ideal way to go forward.”
Advisors should avoid stocks with declining revenues but rising dividends, says Kirby—stocks like Coca-Cola, Caterpillar, Mattel and Century Link are often named as blue-chip dividend payers whose ability to grow has become strained in recent years. “Coca-Cola revenues have been down every year for the past several years,” says Kirby. “Their dividend payout ratio is 75% to 80%, their yield is 3%, they’re paying out everything they can right now and they’re not growing.”
Moving forward, real estate, retail, consumer staples and restaurants are all popular dividend-paying sectors prone to disruption from companies like Amazon, Google and Tesla.
Even lower-yielding, growing, blue-chip dividend-growing stocks are at risk. Strategies like the Dogs of the Dow, which selects the 10 highest-yielding stocks from the Dow Jones Industrial Average each year, or the S&P 500’s Dividend Aristocrats, which selects companies with at least 25 years of dividend growth, are vulnerable.
“There was a feeling of security that came with the strategy: If a company makes it into the Dow 30, it’s already one of the biggest and best-capitalized companies that can’t go out of business,” says Colyer. “That’s not the way it works, though. Dow companies go out of business, fall out of favor and cut their dividends all the time. With the Dividend Aristocrats strategy, you trip on companies on their way from being an Aristocrat to not being an Aristocrat. The list of those companies is quite large.”