• Introduction: The Decline in Dividends
  • A Simple Solution to a Complex Problem
  • A Financial Fort Knox
  • Conclusion
  • Exhibits

Introduction: The Decline in Dividends

As economies stumble in a manner not seen since the Great Financial Crisis articles on the collapse of dividend yields have exploded. A particularly informative article by the New York Times documented that historically dividends accounted for over 40% of the S&P’s returns but that dividend cuts would be severe due to the crisis. The paper also drew attention to the fact that investing in “…so-called Dividend Aristocrats”1 or in companies that pay larger dividends has proven to be a poor investment decision over the last 25 years.2

On the latter point Kailash finds this to be anything but surprising. In our pieces The Dividend Deception and its companion piece The Dividend Deception Part II, A Call for Active Management Kailash documented:

1. “Yield chasing” had inflated valuations of high-dividend firms to a level never seen before3
2. The top dividend paying firms in both the Large Cap and Small & Mid Cap spaces were not only at record valuations but also distributing record payments relative to cash-flows despite falling ROEs
3. Explicitly warned that the buying binge on simple high dividend yielding ETFs was a recipe for ruin and that active managers of dividend products had a ripe opportunity to outperform these simple ETFs

Since publication every single ETF product mentioned in the report has underperformed the S&P with some returning less than half the index. Adding insult to injury, these dividend products, often touted for their lowvolatility, underperformed the index in the crash from the peak on February 19, 2020.

With endemic dividend cuts and bond yields being pressed lower by monetary policy Kailash was recently challenged by a long-time partner to help locate firms we felt might prove to have durable dividends. While our past work was littered with detailed analysis around payout ratios, aggregate balance sheet scores and valuations, given the macro uncertainty, Kailash chose to take a straightforward approach to this request. This paper employs a set of historical information and a simple fundamental method of selection that could meaningfully improve the durability of payments compared to high-yield focused ETFs.

In our last paper, The Biggest Losers at the Peak we panned a group of catastrophic money losers while noting that firms with 5%-10% earnings yields, long operating histories and healthy balance sheets were prizes worth having. This paper takes that concept to an extreme. Our criteria to “make the cut” proved so severe that at the end of our intuitive analysis the list comprised only 5 qualifying firms in the S&P500 Universe and a meagre 3 in the Small & Mid Cap Universe.

This is not to say that we believe these are the only companies that can or will maintain their dividends. Rather these are firms that passed some very high historic and current hurdles that points to them being possible gems for income-oriented investors. The last exhibit in the paper uses somewhat relaxed criteria to provide investors searching for durable yield potentially excellent candidates.

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