Dow companies that cut their dividends historically underperform the S&P 500 the year the cut is made, and slightly underperform the S&P 500 the subsequent year. In contrast, Foolish Four companies that cut their dividends tend to dramatically outperform the S&P 500 the year after the dividend cut. The divergence might be explained by those factors that made a company a Foolish Four stock pick in the first place.
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To help answer this question, let's take a look at the historical performance of very large companies that have cut their dividends -- companies like those in the Dow. Although Bank One isn't technically a Dow component, the company exhibits many of the characteristics of other Dow companies. It's a very large financial company, one that has almost double the market capitalization of Dow bank J.P. Morgan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JPM)") else Response.Write("(NYSE: JPM)") end if %>.
In last week's report we noted that dividend cuts occurred at a rate of 3.4% per year. We noted that Foolish Four companies had a higher rate of dividend cuts, 5.8%. RP1 stocks, representing companies that are often in real financial difficulties, cut their dividend at a much higher rate: 28.2% per year.
We'll call the Dow companies that cut their dividends "Dow Cutters." Here's the average performance of all 40 Dow Cutters since 1961, compared with the market averages for that year:
"Year 1" refers to the calendar year in which the Dow company cut its dividend, while "Year 2" refers to the subsequent calendar year.
It's apparent from the chart that the Dow Cutters as a group perform abysmally the year they cut their dividends, underperforming the market averages by 13 percentage points. That should come as little surprise, since dividend cuts are often in response to difficult corporate financial conditions -- conditions that usually lead to a depressed stock price.
The chart also shows that these Dow Cutters on average don't come soaring back the next year after the dividend cut takes place -- at least not enough to compensate for the first year's poor performance. As a group, the Dow Cutters tend to slightly underperform both the S&P 500 and the Dow the year following the cut.
Let's look a little closer at these Dow Cutter returns. The following chart shows the Year 1 and 2 performance for the Dow Cutters and certain Cutter subsets:
The chart might look a little complicated at first, but I'll walk you through it. The first line, showing the results of all 40 of our Dow Cutters, depicts the data from the first chart, in a slightly different way. As noted previously, these stocks, on average, underperformed the S&P 500 by 13 percentage points for Year 1 and by 0.9 percentage points the next year. The next two pieces of data on the same line show what percentage of these stocks outperformed the S&P 500 for the respective years, giving a little better picture of how the average stock in each group might perform. For instance, only 25% of our 40 Dow Cutters outperformed the S&P the first year of their dividend cut, while 45% -- not quite half -- outperformed the index the following year.
How about our Foolish Four stocks that cut dividends? Recall from last week that, examining January portfolios only, we found nine F4 companies that cut their dividends. As expected, these companies as a group underperformed the S&P the year they cut the dividend by 2.1 percentage points. But these "F4 Cutters" soared the following year, beating the S&P by 15.6 percentage points. Six of these nine F4 Cutters beat the S&P average the next year, and another (Woolworth in 1995) underperformed by a mere fifth of a percentage point.
Comparing the F4 Cutters with the other, non-Foolish Four Dow stocks that cut their dividends confirms that the F4 Cutters seem to behave very differently. The F4 Cutters don't underperform the S&P 500 nearly as much the first year of the cut. And the 15.6% percentage-point outperformance of the F4 Cutters for the following year contrasts with underperformance of 4.3 percentage points for the Non-F4 Cutters.
The RP1 stocks, those that often represent companies in the most dire financial straits, didn't rebound the year after the cut like our F4 Cutters did. If anything, these RP1 Cutters performed worse than the average Dow Cutter the year following the dividend cut, losing to the S&P by 3.4 percentage points, compared to a relative loss of 0.9 percentage points for the average Dow Cutter.
What can we conclude from this? It appears that the Dow companies that cut their dividends are able to rebound the next year and stem the decline in their stock price. The stock price of the typical Dow Cutter stock might not come roaring back to outpace the market, but it almost keeps up. The fact that most of these troubled companies don't continue to crumble but rather almost keep pace with the market demonstrates the resilience of such downtrodden Dow companies.
Why do the Foolish Four Cutters seem to perform differently than the average Dow Cutter? I can only speculate. In order to qualify for Foolish Four status in the first place, an F4 stock usually has already experienced a significant period of underperformance. The lumps have already been taken; they're screaming bargains -- in retrospect. There's little place for the stock price to go but up. Once investors see that management is addressing the issues facing the company, the price can turn around dramatically. And since the RP1 stock is excluded from the Foolish Four, many of the companies with major, permanent problems have been eliminated.
Bank One's stock performance is a good example of a BSP stock that had markedly underperformed prior to announcing this year's dividend cut. Last year the company's stock price dropped 37%, compared with a 20% gain for the S&P 500.
Non-F4 Dow Cutters likely haven't seen nearly as much a drop in their stock price prior to announcing the dividend cuts, so the recovery in stock price isn't nearly as dramatic. This hypothesis is somewhat testable (by looking at stock prices of all the Dow Cutters in the year prior to the dividend cuts), but I'll have to get back to you on this.
I usually add a caveat section at the end of these studies. One drawback with this analysis is that the number of stocks examined is fairly small, especially with the subgroup analysis. As such, many of the observed differences wouldn't reach statistical significance for such small groups. Another potential drawback is that this analysis doesn't examine stock price results from the actual time the dividend is announced or made, but rather looks at calendar years. This doesn't bother me all that much, since F4 and BSP investors tend to invest in chunks of one year, and don't try to time purchases based on corporate announcements. For the Foolish Four data, only January start dates were analyzed. Finally, for the subgroup analysis, it's possible that differences in the timing of the dividend cuts between the groups could have affected the results, although probably not dramatically.
For those interested, here's a more detailed look at the nine Foolish Four stocks that cut their dividends in the past 39 years, showing how they performed the year following a dividend cut.
Beating the S&P year-to-date returns
(as of 08-01-00):
Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %> +4.6%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %> +30.9%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> -5.6%*
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> -3.0%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %> -19.6%
Beating the S&P +1.5%
Standard & Poor's 500 Index -2.1%
*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 +23.2%
S&P 500 +16.9%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $170,400
S&P 500 $83,700
Returns (%)
Year 1 Year 2
Dow Cutters +2.1 +15.0
S&P 500 +15.1 +15.9
Dow Average +15.1 +17.6
Return Vs. % Beating
S&P 500 S&P
Group (#) Yr. 1 Yr. 2 Yr. 1 Yr. 2
Dow Cutters (40) -13.0 -0.9 25% 45%
F4 Cutters (9) -2.1 +15.6 33% 67%
Dow Non-F4 (31) -16.1 -4.3 23% 39%
RP1 Cutters (11) -8.5 -3.4 31% 39%
Following Year Return
Year Company Ret. S&P Ret. Dow Ret.
1972 Beth.Steel + 4.5 +19.0 +16.7
1972 Int'l Harvestor +35.3 +19.0 +16.7
1972 U.S. Steel + 7.3 +19.0 +16.7
1976 Anaconda +78.7 +23.8 +29.4
1988 Texaco +43.0 +16.8 +13.7
1992 Allied Signal +46.1 + 7.7 +11.0
1992 Gen. Motors +10.6 + 7.7 +11.0
1994 IBM +29.7 + 1.3 + 3.7
1995 Westinghouse +37.2 +37.4 +36.7
Average +32.5 +16.9 +17.3