The Key To Avoiding Dividend Cuts
Dividend cuts are the worst.
Unfortunately, I've experienced a couple of them over these last few years, though thankfully none as bad as what V.F. Corporation (VFC) has been shelling out this year (two cuts in 2023 - the first by 41% and then, more recently, by 70%).
If you plan on investing for any extended amount of time, you're likely to experience at least one of them yourself. Sometimes they come out of nowhere, and there's just nothing you can do, but one way that you can take extra precautions against dividend cuts is to pay extra attention to the Payout Ratio - a good litmus test for a company's ability to sustain and even grow its dividend payments.
The Payout Ratio represents the percentage of a company's earnings that it chooses to distribute as dividends. The lower this ratio, the more reassuring it is for us as investors.
A low Payout Ratio indicates that a company is not overextending itself to pay dividends, and implies that it'll have an easier time sustaining and even growing those payouts over time.
Source: Seeking Alpha | SNA Dividend Scorecard
A prime example of this is Snap-On (SNA), one of the 10 stocks in "My Perfect Portfolio." Snap-On's Payout Ratio is only 35%, meaning they retain the majority of their earnings to reinvest in their business or save for a rainy day.
Such a conservative approach in the dividend department gives us some insight into the company's financial prudence, and sets the stage for the possibility of future dividend growth (which SNA has done a great job with so far - look at that dividend growth rate!).
Source: Seeking Alpha | LEG Dividend Scorecard
However, not all companies are like Snap-On. Take Leggett & Platt (LEG), for instance, which is sporting a Payout Ratio near 120% and is currently paying out more in dividends than it's earning.
Yes, LEG has a 7.8% dividend yield, and that might have you seeing dollar signs, but this scenario is far from sustainable. We'll see what happens, but this may be the makings of a certified "Yield Trap".
A yield trap may lure you in with its temptingly high dividend yield, but it's a short-lived attraction. Continuing to pay out more than you earn is a path that ultimately leads to dividend cuts, and it's crucial to see beyond the yield and focus on the sustainability of those payments.
With that said, I want to hear from you: Do you know of any yield traps that we should stay away from? Write to me here and let me know. I can think of five stocks that look like yield traps and you’d be doing yourself a big favor by avoiding them at all costs.
Also, a big thank you to the 10 readers who responded to last week's newsletter. You all rock, and I loved the stock ideas you shared with me! 🙌
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IN MY PORTFOLIO
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ICYMI
REALTY INCOME: The Good, the Bad, and the Future
Realty Income (O) is hands-down the most popular real estate investment trust on the market, as it offers consistent dividend income, dividend growth, and historically substantial share price returns.
It's also one of the biggest positions in my portfolio, and in this video, we'll be going through a rundown of the company to talk about where it's been and where it may go from here.
CAREFULLY CURATED
📺 Free REIT Analysis Spreadsheet - Russ Knopf is a good friend of mine, and I know how much he had slaved over the REIT analysis spreadsheet he's giving away in this video. The spreadsheet details over 100 REITs, and offers a breakdown of each one's dividend stats, growth, and debt profiles.
🎧 Charlie Munger's First Podcast - As far as I know, this is the only podcast that Charlie Munger has ever been on. What more can I say?
📚 3 Dividend Stocks The Richest Man In America Might Have Loved - John D. Rockefeller, whose fortune was estimated at being over $400 billion in today's dollars - was a passionate dividend investor and realized that dividends have enormous power to generate long-term wealth. Here are 3 great dividend stocks that he might have owned if he were around today.
SINCE YOU ASKED
"What's your weekly, monthly $$ contribution to your portfolio?"
- @1levski | YouTube
Every single week — rain or shine — I'm investing a combined $215 across both of my portfolios.
However, when I first started investing a few years ago, my weekly contributions were a lot smaller. I started with maybe $25 per week, and have upped the amount from there.
Over time, my goal is to keep increasing this amount even more!
Have a question? Ask me here to see it featured in an upcoming newsletter.
DREAMING OF MORE DIVIDENDS?
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