One of the hard lessons dividend investors learned during the coronavirus market tumble of 2020 is that when companies need to rapidly conserve cash, they tend to be apt to cut or suspend dividends.
The second part of the lesson is that dividend disappointment can be avoided by focusing on companies with strong balance sheets. While high yields are alluring, history, including 2020, is littered with examples of big dividend yields masking weak balance sheets. Those are the types of companies that are most likely to deliver negative dividend action in the name of capital conservation.
While removing dividend offenders from the investment lexicon is impossible, particularly when interest rates are low, the outlook for sustainable payouts is bright today thanks to good old cash.
As noted above, years of low interest rates encouraged companies across an array of sectors to borrow on the cheap and plenty used that cash to finance dividends and buybacks. That’s fine for companies that already have strong balance sheets, but eventually debt has to be serviced, meaning firms with weak cash positions could be pinched by simultaneous debt and dividend obligations.
Fortunately, data indicate S&P 500 companies, broadly speaking, have strong cash positions. Many fund shareholder rewards without issuing corporate bonds. Conversely, if they opt to go that route to take advantage of low rates, they can pay the tab.
“In Q1’21, S&P 500 Industrials (Old) cash and equivalents stood at $1.81 trillion,” notes First Trust Chief Market Strategist Bob Carey. “The all-time high was $1.89 trillion, set in Q4’20.”
Alone, that’s an impressive data point, but it’s all the more meaningful when accounting for the expectation that S&P 500 dividends could hit a record in the current quarter and that companies are buying back substantial amounts of their own equity.
“From Q1’16 through Q1’21, cash holdings rose from $1.35 trillion to $1.81 trillion, or a gain of 34.07%,” says Carey. “What is interesting is that S&P 500 Index companies spent a combined $5.65 trillion on stock dividend distributions and stock buybacks over that same period (not shown in chart), according to S&P Dow Jones Indices. Stock buybacks accounted for 58.23% of the $5.65 trillion.”
In other words, data support the notion that investors may be treated to another golden era of shareholder rewards. This time around, however, it appears as though companies have the means to support those rewards.
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