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May 2023

Checking in on Dividend Payouts

Key Points

  • Relatively low dividend payouts suggest certain companies are better prepared ahead of a potential recession
  • Attractive dividend payers tend to operate more resilient businesses
  • Dividend sustainability remains a key focus for client portfolios

Last quarter, we examined the historical evidence of the resilience of dividend stock income through recessionary periods. Simply put, historically, we’ve seen much less volatility in dividend payments compared to earnings. Are there any metrics we can use to get a read on the likely outcome for dividends should we enter into a recession in the relatively near term?

Directionally, perhaps, but not with any specificity. Recessions tend to have different direct causes and impact different areas of the economy with different degrees of severity. Also, the life cycles of businesses in aggregate (that may put them into the ranks of attractive dividend payers) don’t necessarily correspond to the economic cycle, so the mix of sectors within the dividend stock universe also evolves over time.

However, going back to the basics of dividend health can help. A key measure of how likely a dividend is to continue to be paid (or grow) is the payout ratio, which is the measure of what percentage of available earnings, or cash flow, is paid out to shareholders. The lower, the better. Earnings and cash flow can be impacted by recessions, and a business typically has other important uses for its cash flow, such as investing in current operations, or growth, or managing leverage.  

Attractive dividend payers tend to be more stable businesses, with more resilient earnings and cash flows, and therefore can sustain higher payouts. However, that doesn’t take away from the fundamental fact that lower payout is safer, all else being equal. Lower payout ratios may result in lower volatility when worsening macroeconomic conditions impact earnings and cash flows, and also provide an opportunity for faster growth when those conditions are improving.

As the chart shows, the aggregate payout of our dividend universe has started this period of earnings deceleration with the lowest payout ratio in the almost two decades for which we have data. That should reflect a bigger cushion approaching the unfolding macroenvironment, which suggests dividends and dividend stocks are relatively well positioned ahead of this potential downturn. Further, for client portfolios, we spend a large portion of time focused on the dividend health of each and every holding in order to drive improved relative outcomes compared to the dividend universe as a whole.

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