3 Key Steps To Avoid Dividend Cuts
There are two things that dividend investors fear more than anything: Never reaching financial freedom and dividend cuts — and the two aren’t totally unrelated.
I genuinely believe that anyone can achieve financial freedom by staying patient, disciplined, and consistent with their investing, but if you expose yourself to too many dividend cuts, you’re basically swimming upstream. You're putting in all this effort to get ahead, but the current keeps pulling you back, making it tough to make progress.
While it’s true that dividend cuts do sometimes come out of nowhere, like in the somewhat recent case of WPC, there are a few key signs to watch for that can suggest a higher degree of dividend safety.
First, look for a consistent history of dividend payments, or better yet, dividend growth. If a company has been steadily increasing or maintaining its dividends over the years, that's a promising sign. It shows they're committed to rewarding shareholders through thick and thin — the opposite of what you’d find with a dividend yield trap.
This is why many investors flock to Dividend Aristocrats and Dividend Kings. Their extensive track record of dividend growth (25 consecutive years or more for Aristocrats, 50 or more for Kings) is attractive to investors looking for a source of passive income they can rely on.
With that said, it’s important to keep in mind that even the mightiest dividend king can be knocked off its throne. Just look at VFC, a fallen dividend king that served shareholders two dividend cuts last year.
Source: Seeking Alpha | VFC Dividend History
The second sign of a safe dividend is the payout ratio. This is the proportion of earnings a company pays out to its shareholders as dividends.
A lower payout ratio tells you that a company is retaining more of its earnings, which can be reinvested back into the business for future growth or used as a buffer during tough times. As a very general rule of thumb, we like to see companies with payout ratios below about 60%, as this indicates a balance between rewarding shareholders and maintaining financial flexibility.
Fortunately for us, there are plenty of stocks out there with payout ratios well within our rule of thumb.
Source: Seeking Alpha | WSM Dividend Summary
For example, WSM has an extremely conservative payout ratio of only 23% — plenty of wiggle room.
A payout ratio this low can be common in stocks with higher dividend growth rates. That extra room to breathe makes it easier for the company to sustain consistent dividend increases.
And of course, you can't forget about the company's overall financial health. Look for things like revenue and earnings growth, consistent cash flow, and manageable debt levels. A company with these qualities is better equipped to weather tough times, and is more likely to keep delivering those dividends safe and sound.
With that said, I want to hear from you: When you think of “safe” dividend stocks, which ones come to mind? Reply to this email, or write to me here and let me know.
And a big thank you to all of the readers who responded to last week's newsletter! You can read some of the responses down below in the "Hot Takes" section. 👇
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ICYMI 👀
I Just Made A BIG BUY On These 5 Dividend Stocks
I finally ripped the band-aid off and sold both AT&T (T) and Verizon (VZ). With the proceeds from the sale, I made a big buy on these 5 dividend stocks.
CAREFULLY CURATED 🔍
📺 Simplicity Is Key - My man Lanny has a 70+ stock dividend portfolio, but he's ready to clean house. In this video, he talks in-depth about how he came to have so many different holdings, and how being too over-diversified (more specifically, how having too many small positions) can negatively impact your focus and potentially dilute your returns.
🎧 Dividend Fuel - Over the past decade, the oil industry has become increasingly controversial and subsequently neglected by investors. No one knows when the industry's expiration date will come due, but there are great value and dividend growth investments to be made in the meantime.
📚 Is CPG Doomed? - A very interesting article on trends in consumer packaged goods. It delves into the success of private label brands such as Trader Joe's, Target's (TGT) efforts to replicate their mojo, and the hurdles confronting emerging CPG brands as they compete with retailers' in-house labels.
SINCE YOU ASKED 💬
"I have no idea what good stocks to buy...I feel lost."
- @tonyk6154 | YouTube
No need to feel lost!
Consider exploring ETFs (exchange-traded funds) – they're an easy and excellent way to invest if you're worried about picking stocks. Many people actually prefer to ONLY invest in ETFs because they make building wealth so simple.
Personally, I regularly invest in VOO, an S&P 500 ETF, on a weekly basis, and also in SCHD, an ETF focused on dividend growth comprising over 100 dividend-paying companies.
Have a question? Ask me here to see it featured in an upcoming newsletter.
HOT TAKES 🔥
Last week, I asked readers about their approach to building an invincible portfolio. Here are some of the responses:
Michael said: You can’t prevent recessions but you can prepare for them. Warren Buffett has made more money during a recession than a good stock market. He keeps a minimum amount of cash on hand to help out companies that were skinny dipping in the good markets at a very nice profit for himself and his share holders. With the market reaching new highs I have still been putting money in my accounts but I’m reserving it in cash for the next market down turn. I want to keep cash at 2 to 5% of my account balance.
Jeff said: My approach is to stick with my allocations. Since I’m in my 40s, I go with 30% dividend (SCHD), 30% growth (VGT, thinking about QQQM), 30% cornerstone (VOO), and 10% cash (VMFXX).
Nigel said: My approach to creating an invincible/resilient portfolio is to invest in companies that provide goods and services that people already need and will likely always need. I figure that if I’m doing this right, my portfolio will have a lower overall Beta score, and likelier less wild growth, but all-in-all a smoother ride.
James said: The first thing that comes to mind with building an invincible portfolio is making sure you constantly make your investments each month. If you aren’t doing the same amount each month, what is the point of building a compounding investment? Next, stick to what you love or know when you start investing as it can help you build easily and early. For example, I work at Walmart so I know Walmart decently well. Lastly, don’t let FOMO decide investments. This goes for buying and selling. The fear of missing out can and will cause you to lose money.
DREAMING OF MORE DIVIDENDS? 💰
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