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Dividend Sinners and Fallen Angels
J.C. Penney (JCP) is a storied name in retailing. A once proud company, it has fallen on hard times. For the dividend investor, those hard times date back to 1998 and 1999, when the company chose to just maintain its annual disbursement rate rather than increase it, as it had done in previous years. A company with a penchant for raising its dividend suddenly stopping that upward trend is a bad sign for dividend investors. And, indeed, that was just the case here.
By 2001, the annual dividend had fallen to just $0.50 per share from $2.18. That’s a massive drop for anyone relying on dividend income to pay for daily living expenses. Worse, the cutting started as the country was heading into a recession. However, the retailer started to increase the dividend again in 2006. But during the 2007-2009 recession the dividend again flat lined.
Most investors could clearly see that J.C. Penney was a struggling enterprise. That said, the $0.80 per share annual dividend held for several years. Along the way, the company looked to be taking steps to right the ship. With the May 16, 2012 announcement that its new direction had been a disaster, the company committed the ultimate dividend sin—it eliminated its dividend. The elimination, while not completely a surprise for a company trying to turn itself around, was nonetheless a shock. That’s particularly so for someone looking forward to that quarterly check to pay for food, rent, medicine, or anything else.
Dividend investors, meanwhile, should compare the events at J.C. Penney to those that are unfolding at Paychex (PAYX). Paychex is a leader in providing payroll and other services to small and-medium sized businesses. The 2007 to 2009 recession, which hit small businesses particularly hard, took a toll on the top and bottom lines at Paychex, causing it to stop increasing its yearly dividend.
For a company with a strong history of yearly dividend increases, dividend investor’s warning flags were up. The quarterly dividend remained unchanged at $0.31 per share from the third quarter of 2008 until the third quarter of 2011. In the fourth quarter of 2011, however, the quarterly dividend was increased to $0.32 per share. Dividend investors could breath a sigh of relief.
The big difference, of course, is that performance at Paychex was improving, while J.C. Penney’s had continued to flounder. However, it was, essentially, a single business decision that doomed Penney’s shareholders to a dividend cut. Paychex simply kept doing what it did so well through a difficult economic period and came out on the other side, bruised but not battered. Clearly, Paychex was a fallen dividend angel that had regained its wings.
Most investors who use dividends as a source of spending money think about holding a stock indefinitely. The idea is to benefit from the wonders of capitalism via regular distributions to shareholders of the money that is rightfully theirs via their ownership stake in a business. A company’s employees get paid their salaries, its investors get their payments in dividends.
But life isn’t as simple as buy and hold. Even great companies go through hard times. For example, McDonald’s (MCD - Free McDonald’s Stock Report) went through a period of soul searching that ultimately resulted in renewed vitality. Looking back now, it seems a distant memory. For a dividend investor living through that period, however, it could have been pretty harrowing.
Unfortunately there is no clear lesson to be culled from the examples of J.C. Penney or Paychex. What should be noted, however, is that when a company with a history of increasing its annual distribution stops doing so, dividend investors need to take notice. Clearly, management is making a statement about the business of which you own a part. The next few years could be critical to your financial well-being.
If the company’s performance continues to falter, getting out before the dividend is cut again, or, worse, eliminated, makes complete sense. If the business seems to be stabilizing, sticking around could, ultimately, be rewarding. But taking a close look at quarterly earnings reports and any news in-between becomes vital. Dividend investing is not a “set it and forget it” investing approach, even if you buy “great” companies. This is particularly true if your income depends on those dividends being paid.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.