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Show Me the Money!

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In the movie Jerry Maguire, football player Rod Tidwell (played by Cuba Gooding Jr.) agrees to continue to retain the services of his sports agent Jerry Maguire (played by Tom Cruise). This agreement came about only after Maguire re-established his commitment to get Tidwell a new, lucrative contract.  That scene where Maguire screams, “Show me the money!” in a telephone call is one of the most memorable scenes in Hollywood cinema.

Investors are really no different. They want the companies they invest in to also show them the money. And if companies don’t respond accordingly, then their share prices will get punished. Money in this case refers to the dividends companies pay their shareholders. Though dividend growth amongst Canadian and U.S. companies has been strong for many years, the situation has been changing.

It has been widely reported that many companies in the Canadian stock market, as represented by the commodity-heavy S&P/TSX, have cut their dividends in the past 12 months. This has largely been driven by the decline in commodity prices. Things are less dire in the U.S. but it appears to be at an inflection point. For example, FactSet reported less than three months ago that nine (9) out of ten (10) sectors in the S&P 500 are forecasted to experience slower dividend growth in 2016.


FactSet reported less than three months ago that nine (9) out of ten (10) sectors in the S&P 500 are forecasted to experience slower dividend growth in 2016.


 

Dividend Growth is Cyclical

Dividend-Growth-Waning_2016-06If you click on the accompanying graph, then you will see the dividend growth of the S&P 500 going back 27 years. These dividends on a 4-quarter trailing basis compared to a year earlier. As you can see, dividend growth typically increases at the beginning of each business cycle and decreases towards the end of each business cycle (yellow arrows).

Though companies are loath to cut their dividends, they do so periodically, typically during recessions (grey shaded areas). Not surprisingly, you can also see that declining dividend growth looks to be a leading indicator of recessions. In fact, in the recessions that began in 1991 and 2007, they occurred when dividend growth slowed to approximately +12% and +11%, respectively. Those appear to be fairly strong numbers, which confirms companies avoid cutting their dividends, even when entering recessions. As for the Tech Bubble Crash in 2000 and its subsequent recession less than a year later, in hindsight, should had be obvious given dividend growth decreased to +3% in 1999.


In fact, in the recessions that began in 1991 and 2007, they occurred when dividend growth slowed to approximately +12% and +11%, respectively . . . I find the factoids about 1991 and 2007 particularly interesting given dividend growth for the past 12 months (grey dashed line) has slowed to less than +8%.


I find the factoids about 1991 and 2007 particularly interesting given dividend growth for the past 12 months (grey dashed line) has slowed to less than +8%. It is also interesting because, unlike the S&P/TSX, the S&P 500 has much less exposure to commodity-type firms. As mentioned earlier, FactSet reported that the declining growth in companies showing investors the money is widespread.

 

Can Dividend Growth be Sustained?

It really isn’t too surprising to see dividend growth wane since peaking 3+ years ago. After all, companies in the S&P 500 have been returning capital to shareholders at an increasing rate despite earnings growth having gone negative in the past 3 or 4 quarters (depending on which data provider you use). As a result, payout ratios have exceeded 100%. And if you question the validity or quality of those earnings, given non-GAAP earnings are now abnormally higher than their GAAP counterpart, then payout ratios would be even less sustainable. All this would make future dividend growth even more challenging to sustain at a time when banks are tightening lending standards, presumably due to rising bad loans and bankruptcies.


All this would make future dividend growth even more challenging to sustain at a time when banks are tightening lending standards, presumably due to rising bad loans and bankruptcies.


Whether or not you believe waning dividend growth is a leading indicator of economic recessions, please consult an investment fiduciary before making any investment decisions.

 

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