Why Dividend Rate Cuts Happen – Competition

In our continuing series on dividend cuts and how to avoid them, today we are going to look at what the effects that market and sector pressures have on making company’s cut dividends, and how you can train yourself to see them coming.

As we discussed previously dividend cuts can beat up your portfolio so they should be avoided at all cost. By exploring some of the main reasons that cuts happen perhaps we will better understand why they happen and how to purge these stocks before the bad news hits.

I Cut Because You Cut

Dividend payments come out of a company’s income- never forget that. Almost every company that pays a dividend would love nothing more than to not have to pay that dividend or at least to cut it back and instead direct that income into growing the business or paying down debt. When a company sees its competitor slashing their rate they may see this as an opportunity to cut their rate also, they will say things like:

• We feel it is necessary to reduce our rate to stay competitive with the market place…
• At this time we feel our dividend rate is out of line with overall market trends…
• With our competition reducing its rate we feel it will be necessary to follow suit in order to remain competitive…

I make this sound somewhat malicious, and believe me sometimes it can very well be. There are some companies out there that will take a competitor cut as an opportunity to do the same themselves, monkey see monkey do.

I Cut Because We All Need to Cut

It is not always as devious as my previous example indicates, sometimes there are market conditions that effect an entire sector. You need to look no further than the recent banking crisis in the US. Dividends were cut by several banks one by one as they approached their reporting period. There quarter end accounting showed that they really had no choice but to cut rates just to stay alive. Here it is like a game of dominoes, the fall of one indicates that the next will soon fall.

How to See These Dividend Cuts Coming

When you hear that a competitor to a company you own has slashed its rate don’t laugh and think that you are safe. Think hard about how different your company has been performing in relation to the competitor. Is there something effecting the sector which is about to hit your company, or are the bad times limited to your competitor. Think also about what type of management you are dealing with- are they able and trustworthy managers or will they use this as an opportunity?

If you see the signs of trouble evaluate your position and you may well want to get out while you can.

Other Parts in the Series

Why Dividend Rate Cuts Happen- Financials