Bank One recently cut its dividend in half and the stock price soared. Dividend cuts made by large corporations like those represented in the Dow occur only about once a year on average. But these cuts occur more frequently in Foolish Four stocks and with a dramatically higher frequency for the RP1 stock, often the Dow stock that's on the weakest financial footing.
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Bank One's shareholders will now be receiving a quarterly dividend of 21 cents a share instead of the 42 cents they've grown accustomed to, halving the current annual dividend yield to about 2.5%. The move was made in conjunction with the July 19 announcement of the struggling bank's cost-cutting measurements and plans for restructuring.
Normally, a dividend cut isn't much to cheer about, but the news sent Bank One's stock soaring, closing up almost 8% for the day. Through yesterday the stock has climbed 10.2% since the announcement, compared with a loss of 1.6% for the S&P 500 -- helping to drive the BSP Portfolio ahead of the S&P 500 for the year. Having suffered through the slings and arrows of Bank One's outrageous misfortunes last year, it seems that many investors may finally be rewarded.
It's not every day a behemoth company like Bank One cuts its dividend. But how common is it? And what might the consequences be for investors holding a stock when a company does the mysterious shrinking dividend trick?
I thought this would be an opportune time to take a closer look at Dow dividend cuts. Just how often do huge, well-established companies like those in the Dow cut their dividends? How often does it happen to Foolish Four companies? And most importantly, how do the stocks of these companies perform after a dividend cut?
Although the history of BSP goes back a relatively short 13 years, we have 39 years of Dow history available to us in the Dow Dividend Spreadsheet. Let's take a look at the history of Dow dividend cuts since 1961. I will use the term "dividend cuts" to include any sustainable cut made by a company below its baseline from the previous time period.
From 1961 until the end of last year, Dow companies have cut their dividend a total of 40 times. (Actually it's 43 times, because three companies have made dividend cuts twice in the same year. For simplicity's sake, I'll only count such a company once.) Because our database contains 30 Dow companies each year over a history of 39 years, there have been a total of 1170 company-years (30 times 39) in all. Thus, the chances that any Dow company cutting its dividend in any particular year is 3.4% (40 out of 1170). On the average, for the past 39 years, about one Dow company a year cut its dividend.
But these dividend cuts are by no means distributed evenly over time. They tend to follow periods of recessions, where sustained economic slowdowns have led to severe problems with a company's bottom line. A large majority of Dow companies that cut their dividends were in cyclical businesses that hit a low point in their cycles -- businesses like steel, cars, or heavy equipment manufacturers.
In more than half the years (20 of the 39 years), there haven't been any dividend cuts by Dow companies at all. But in 7 of those 39 years, either 3 or 4 Dow companies cut their dividends, accounting for 60% (24 of 40) of all dividend cuts. The record-setting years were 1971, 1975, and 1982, when four companies cut dividends. The other high-activity years (with three dividend-cutting companies each year), were 1978, 1991, 1992, and 1993.
Not a single Dow company has cut its dividend since 1995, when Woolworth (reorganized as Venator Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: Z)") else Response.Write("(NYSE: Z)") end if %>, and dropped from the Dow in 1997) eliminated its dividend entirely. We're approaching the longest dry spell for Dow dividend cuts since the five-year period from 1963 through 1967. So we can't blame the recent historic low dividend yields of Dow and Foolish Four stocks on dividend cuts. There are other explanations for the low yields, as we discussed last week.
What about dividend cuts made by our Foolish Four companies? The following analysis includes only those Foolish Four stock portfolios that used annual January start dates, the starting dates used in the Dow spreadsheet. There were 156 (4 times 39) F4 stocks in all since 1961 (including stocks that were renewed for a second year). Of these 156 Foolish Four stocks, 9 (or 5.8%) cut their dividend, a rate higher than the 3.4% for the entire Dow group.
The higher rate for the dividend cuts for F4 stocks is not all that surprising, since Foolish Four companies tend to be temporarily out of favor. Companies rarely cut their dividends when business is good, unless it's part of a major reorganization effort like we noted recently at Ford <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>. We invest in Foolish Four companies with the hope that these "distressed" companies will turn around.
What about the RP1 stock, thecompany in the Dow whose yield is the very highest in relation to its stock price? Recall that the Foolish Four strategy drops the RP1 stock, with the assumption that often this is a stock that might be in real financial trouble, not just perceived financial trouble. For example, Philip Morris <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MO)") else Response.Write("(NYSE: MO)") end if %>, inundated by legal challenges, is the current RP1 stock. Of 39 RP1 stocks since 1961, a whopping 11, or 28.2%, cut their dividend within the year.
Here's the frequency of dividend cuts by RP position, along with a summary of what we've found so far:
What are the take-home messages from all this data? It's clear that large companies like Bank One and those in the Dow just don't cut dividends very often. And those companies that do have tended to pay relatively high dividends before the dividend cut, as noted by the high frequency of top RP stocks that show up on the list.
What might the latest dividend disappearing act by Bank One portend for the future returns of the stock? Does the dividend cut signal a bottom or is there more pain ahead? Next week we'll take a closer look at those Foolish Four stocks that cut their dividends to find out how they fared after the cut.
Beating the S&P year-to-date returns
Stock Dividend Cuts (%)
RP1 11/39 (28.2)
RP2 4/39 (10.3)
RP3 2/39 (5.1)
RP4 1/39 (2.6)
RP5 2/39 (5.1)
Strategy Dividend Cuts (%)
All Dow stocks 40/1170 (3.4)
All RP1-5 stocks 20/195 (10.3)
All F4 stocks (RP2-5) 9/156 (5.8)
All RP1 stocks 11/39 (28.2)
All Dow, non-RP1-5 stocks 20/975 (2.1)
(as of 07-25-00):
Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %> +5.9%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> +26.0%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> -4.9%*
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> -1.9%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %> -11.3%
Beating the S&P +2.8%
Standard & Poor's 500 Index +0.4%
*Includes Visteon <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VC)") else Response.Write("(NYSE: VC)") end if %> spin-off
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +23.5%
S&P 500 +17.3%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $172,600
S&P 500 $85,800