Correction to This Article
A July 6 Business article incorrectly characterized how many financial companies have cut their dividends this year. Seventeen of the 20 companies in the Standard & Poor's 500-stock index that have reduced their dividends are financial companies.

Long a Reliable Profit Source, Dividends Start to Crumble

Homebuilder D.R. Horton halved its dividend after the housing market crashed.
Homebuilder D.R. Horton halved its dividend after the housing market crashed. (By Mike Fuentes -- Bloomberg News)
By Tomoeh Murakami Tse and Nancy Trejos
Washington Post Staff Writers
Sunday, July 6, 2008

The credit crisis and economic slowdown have become so grave that many companies are chopping dividend payments to their shareholders.

Financial institutions, reeling from the rise in foreclosures and ensuing credit crunch, are making the most drastic reductions. Citigroup, which has recorded billions of dollars in losses on mortgage securities, earlier this year lopped its dividend by 41 percent. So did Wachovia. National City, a major regional bank, reduced its payout by nearly half, and Washington Mutual slashed its quarterly dividend to a mere penny.

"These guys have a long track record of not cutting dividends," said Kevin Shacknofsky, portfolio manager of the Alpine Dynamic Dividend Fund, which has 98 holdings. "The fact that they're cutting now is an indication of how tough the situation is."

So tough that 17 of 20 financial companies in the Standard & Poor's 500-stock index have cut their dividends so far this year, more than in the past five years combined, said Howard Silverblatt, senior index analyst at S&P.

"Dividends are usually the last thing you want to cut," Silverblatt said. "You're not just taking your holders out, but you're telling the marketplace: 'I have a cash flow problem.' "

It's a significant blow to investors, many of whom considered dividend stocks a safe harbor in an environment of falling stock prices. Dividends, which are paid by companies on a fixed basis, provide a steady income and are an important part of the portfolios of many investors, particularly retirees on fixed incomes.

"When you look at dividend cuts in the face of high gas prices, in the face of high commodity prices, in the face of high food prices, this really stings, and unfortunately there's not much you can do about it," said Frank Boucher, a financial planner in Reston with the Garrett Planning Network.

If you have shares in a company that is cutting dividends, you can either sell them and lose money now, or you can stay put and hope the dividends will recover, Boucher said. If your portfolio is too heavily invested in one area, such as financials, you might want to consider rebalancing it, but only if it makes sense for your future, not because you're spooked by the present, Boucher said. "I just think that investors are going to have to be patient," he said.

Although financial institutions have attracted much negative attention for the magnitude of their dividend cuts, they are not the only ones in trouble. Food companies, entertainment businesses and telecom firms have quietly been reducing their payouts as well.

For example, Sprint Nextel, the nation's third-largest wireless carrier, did away with its payout altogether after reporting a massive quarterly loss, in part because subscribers weren't paying their bills. La-Z-Boy, the furniture manufacturer, reduced its payout by two-thirds during an industry-wide downturn. And home builder D.R. Horton cut its dividend in half.

"As long as we are producing an operating loss, then it doesn't make sense to continue to pay the level of dividend that we were," Donald Tomnitz, chief executive of D.R. Horton, said in a conference call in May.

To be sure, numerous U.S. companies are still increasing dividends -- thanks to the four years of annual double-digit earnings growth they enjoyed before the current downturn. Last month, medical technology company Medtronic boosted its payout by 50 percent, while electronics retailer Best Buy raised its by a more modest 7.69 percent. Even a financial firm, BB&T, increased its dividend, albeit by just 2.17 percent.

If you look at dividend payouts in the past 12 months, there has been a 9.73 percent increase overall, Silverblatt said. Still, that's less than the rate the payouts rose from 2004 to 2007. Each of those years, dividend increases exceeded 11 percent, he said. Many companies are now decreasing the rate at which they increase their dividends.

"A lot of companies will raise their dividend in correlation to their earnings growth," said Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity Fund, which has 80 to 100 stocks in its portfolio, all of which must pay a dividend. "You've seen some definite slowing in earnings growth, so we have seen a slowing in increase in dividends."

Analysts point out that corporate balance sheets are generally healthy. But with the economic outlook uncertain and earnings expectations dropping for the months to come, money managers are treading carefully.

Wordell, a value investor, said some financial companies are trading at "very, very attractive prices at the moment."

"But the ones we are holding off on are the ones we think are still going to have to cut dividends or raise capital," he said. "We're just not going to get in front of that. . . . Banks right now are in capital-preservation mode."

Any investor looking to make moves in this market should do a lot of research. Look at the company's earnings and outlook. Is it raising capital? Is it highly leveraged?

"Dividend investing is just like regular investing," said Shacknofsky of the Alpine Dynamic Dividend Fund. "Focus on the fundamentals. Focus on companies that are stable."

Paul Larson, equities strategist for Morningstar, said investors should determine whether the company's profit is actually covering the dividend payments. If it is not, he said, "that's definitely a yellow flag that a cut could be on the horizon."

The pattern this year has been for companies' profits to fall below the payouts for two quarters and then for the dividend to be cut, Larson said.

Dan Genter, chief investment officer of RNC Genter Capital Management, who uses a "high dividend strategy" in investing, also looks for disproportionately high dividend payout ratios compared to cash flow in a declining earnings environment.

"You're dealing with it in the financials, you're seeing it in the autos," Genter said. "All of that is really beginning to flow through the system and beginning to affect overall earnings. . . . Anytime you're in that situation where you've had a significant decrease [in earnings] and you've got a slowing macro environment on top of it, certainly dividend increases are going to go into jeopardy."

© 2008 The Washington Post Company