The Pandemic’s Dividend Dilemma
With the economic stress and state-mandated closures of the COVID-19 pandemic, businesses have been under significant pressure. Due to the inherent uncertainty of the situation, many organizations have been faced with the inability to estimate future revenue and earnings, leading some companies to cut or suspend their dividend payments, or the profits distributed by a corporation to its shareholders.
From an investor’s perspective, dividends provide income, and for retirement plan investors, income from consistent returns is an important component to achieving retirement readiness. The economy has been in a low interest rate environment for some time now, which has made achieving income more difficult. Thus, investors have looked towards dividend-paying equities to supplement the income that they are not receiving from fixed income investments.
The Impact of the Pandemic
A major distinguishing factor leading into this recession is that many businesses had strong balance sheets and the potential to withstand temporary demand hits. While balance sheets are stronger than they were during the Great Financial Crisis, the future is unpredictable. The potential for a second wave of the virus, future shutdowns, and the readiness of a vaccine may push businesses to the point where balance sheets are strained.
In fact, the pandemic has already taken a significant toll on dividends. As of June 30, 2020, there have been at least 41 dividend suspensions. An organization may suspend their dividend for a set period of time, or indefinitely, if it is under financial strain. The recession that COVID-19 has brought has forced many organizations to ultimately stop paying out their monthly dividends, as their balance sheets have taken a toll. To put the numbers into perspective, in the ten years prior to 2020 there were only nine dividend suspensions. Additionally, during 2018 and 2019, there were no dividend suspensions. The number of companies suspending dividends this year is clearly concerning to many investors, as the full economic impact of the coronavirus has still yet to be seen.
During past recessions, dividends typically declined approximately one-third as much as earnings. Current expectations are that dividends will fall 25%, or roughly equal to any earnings decline. Due to these circumstances, and the degree of uncertainty, the recovery of dividends is anticipated to take longer than during an average recession. Dividend cuts and suspensions have been concentrated in economically sensitive sectors, where earnings are less predictable. However, more defensive sectors, such as consumer staples and utilities, have also taken a hit. Even if companies can withstand the adverse effects of the pandemic and not suspend or cut their dividends, it is unlikely that payout ratios will rise for most companies.
With the enactment of the CARES Act, there are also restrictions for companies that are receiving aid. Specifically, any company that borrows from the federal government cannot pay a dividend or re-purchase stock until 12 months after the loan is repaid in full. Some of the sectors that underperformed for the first time in years are airlines, air cargo, aerospace, and travel-related companies. These sectors have been provided with a tremendous amount of aid, as the U.S Government is trying to keep them afloat. Companies expected to better weather the storm, such as technology, healthcare, and utilities, have been holding up well, and their stock prices have fared the best.
What Does This Mean for Retirement Plans?
While there is a degree of uncertainty as to whether companies will be able to maintain dividend payout ratios, some sectors will be more capable than others. Since the Great Financial Crisis of 2008, many organizations have shifted to capital-light business models, cutting costs by substituting the use of technology for labor and physical assets. In turn, this has provided organizations with more leverage and stronger balance sheets, making them more resilient during times of crisis. Despite their stronger financial positions, many companies’ dividends will continue to be affected by the current crisis, and income-oriented investors will have to adjust to the situation.
Ultimately, retirement plan investors focused on earning supplementary income are the ones taking the biggest hits. When dividends, which provide a steady inflow of earnings, get cut or suspended unexpectedly, it leaves investors without many options. These income-seeking investors, who are most likely closer to retirement, are forced into uncomfortable positions where they may have to invest in the turbulent market to make up for their losses. Overall, investors will have to adapt to the situation and wait to see how the COVID-19 pandemic continues to pan out for the economy.
Note: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice. Opinions expressed are those of the author, and do not necessarily represent the opinions of Cammack Retirement Group.
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