DIVIDEND STOCKS THAT CUT DIVIDENDS - PART 1

Indeed analysts and economist worldwide believed that the world's economies would face severe hardships. It was due to this belief that countries around the world increased money flows and sovereign debt in the belief that this might save the world from a global economic disaster. Whether it worked will not be known for years to come.

In the face of the crisis many dividend paying stocks went through a dividend cut. But often when a dividend paying stock cuts its dividend, the stock has already collapsed.

For example here is the chart of Wells Fargo Stock (WFC). By the time the dividend cut was announced on March 6 2009 the Wells Fargo stock was already near the bottom of its plunge. On March 6 2009 when the dividend cut was announced, Wells Fargo stock would have made an excellent buy.

Below is the chart of General Electric Stock. By the time the dividend cut was announced on Feb 27 2009, the stock has already plunge and didn't have much further to fall.

Below is the chart of Bank Of America Stock. At the time of the first dividend cut Bank of America stock was still above $30.00. With the second dividend cut Bank Of America stock was down to just above $7.00. Buying Bank Of America stock after the first dividend cut was announced would have been a disaster.

When dividend paying stocks have a dividend cut many investors wonder if the depressed stocks are actually good buys once they have made the dividend cut announcement. In the case of many stocks like AIG and Bank of America, the answer is a resounding no, at least for the past couple of years. In fact the likelihood of stocks like AIG recovering are remote. One thing is certain, when a dividend stock goes through a dividend cut, a investor's dividend portfolio is already damaged. It is probably too late for a dividend investor to sell without significant losses. But for every investor selling someone is busy buying.

However many stocks that have gone through a dividend cut are actually strong companies, trying to survive a rough economic cycle. In some cases the dividend cut is actually the correct thing to do. For my study I picked what I believe is one such company, General Electric. No commissions are taken into account for any of the trades shown here.

GENERAL ELECTRIC IN DISARRAY

When General Electric announced on Feb 27 2009 that for the first time since the Great Depression they were going to do a dividend cut, the stock had already collapsed as had earnings. In December 2007 GE earnings were 68 cents per share. Just a quarter later in March 2008 they had fallen to 44 cents a share. By September 2009 they had fallen to 22 cents a share. General Electric stock had no choice but to go through a dividend cut.

Below is a 10 year chart on GE. I have plotted out the various dividends being paid by GE over the last 10 years. Even at the time of this writing (May 27 2011) the dividend is not at the level it was in 2001.

Within days of the announced dividend cut General Electric stock reached its low of the bear market, falling to $5.73 on March 4 2009.

ARE DIVIDEND STOCKS THAT HAVE A DIVIDEND CUT, GOOD BUYS?

On the chart below I have plotted out a number of key points for General Electric Stock. First is the market panic in Feb 2009 to Mar 2009 which saw the stock trade at an unprecedented low of $5.73

D) The blue line running across the stock volume is the average volume for given days. Anything above the blue line is above average volume. These are the days I am following. I have plotted on the chart the high and low prices for each of the higher volume days.

What I will try to look at is whether or not a stock such as GE stock would be a good buy after the dividend cut was announced. The problem with so many studies of stocks that cut their dividends, is that they are based on an investor buying the stock at the low and selling it at a high point. In hindsight this would be an easy trade. But this is hardly realistic.

Most investors when a stock is collapsing, will run from it. For example when GE stock fell all the way to $5.73 many traders who bought at $10.00 and $9.00 would unload in horror. If an investor bought GE at 9.00 and it fell to $6.00 that is a 30% loss. The average investor would not take a 30% loss, but would be out in a flash. So while it is easy to plot stock decisions based on hindsight, it is obvious just by volume alone that when the February and March 2009 lows came, there were lots of sellers just as there were buyers, but as the stock kept falling, even buyers at what they had thought were lows, became sellers. A stock like GE does not fall to $5.73 without a stock market panic.

The value of doing a strategy such as this is to have this knowledge available to draw upon for such an event in the future. The bear market of 2007 to 2009 was not unusual. The fact that it was primarily focused on financials was unusual, but in bear markets, stocks fall much further than investors realize or even believe. That is why doing a strategy study such as this one, is of significant value as it prepares an investor for the next market collapse and the opportunities that it presents.

In order to be as objective as possible, I will approach this study from a number of angles.

Once the dividend cut was announced General Electric stock fell even further and market panic was already running rampant. The chance of a long term investor buying at such stock market panic levels is slim. At the time of writing this article May 27 2011, GE is trading at $19.47 and I will use that price for a sell point.

STUDY 1: THE INVESTOR WHO ACCUMULATES

If an investor wanted to accumulate shares in lots of 100 shares over the course of the above chart, there is no way that the investor would have bought shares at the low every time, and probably not the high each time. Therefore for this study I will take the average of each high volume day after the stock commenced recovery.

As explained above, I have numbered each high volume day. They run from 1 to 11. Most investors take the approach that the time to buy a stock is at a low point but they prefer not to buy during a market panic or market sell off. During a stock market panic, if the investor has cash available, normally they will sit at the sidelines until the stock market bottoms appears to have been reached. With GE Stock that appeared to be the case by June 2009 about 3 months after the market panic of Feb - Mar 2009 had ended and the market seemed to have made a bottom. The first period then is marked 1. Starting at 1 and going through to 11, here are the averages for those high volume days. Based on this study, our fictitious investor buys 100 shares at each average.

1. 11.74 - 100 shares = 1174.00

11. 20.26 - 100 shares = 2026.00

TOTAL CAPITAL INVESTED - $18377.00 / 1100 shares = $16.70 average cost - sold today at $19.47 = $3040.00 gain = 16.5% gain.

TOTAL RETURN WITH DIVIDEND INCOME = 18.8%

This is a return from June 2009 or about 23 months of about 0.82% per month. 

SUMMARY OF STUDY 1: Therefore based on the above scenario an investor who bought after the dividend cut, profited by 16.5%. The question here would be, would an investor risk their capital on General Electric Stock after such a collapse for a return of 0.82% per month? Personally I would consider this a reasonable trade, but as I prefer selling puts, I would not have taken this trade.

STUDY 2: THE INVESTOR WHO ACCUMULATES STARTING ON THE DAY AFTER THE ANNOUNCED DIVIDEND CUT

Taking the same figures from the first study marked number 1, let's add in 100 shares at the close of March 2 2009, the first trading day after the announced dividend cut. That changes the outcome quite dramatically.

A. BOUGHT 100 SHARES AT CLOSE MAR 2 2009 -  $7.60 = $760.00

11. 20.26 - 100 shares = 2026.00

TOTAL INVESTED - $19137.00 / 1200 shares = $15.95 average cost - sold today at $19.47 = $4227.00 gain = 22.08% gain.

TOTAL RETURN WITH DIVIDEND INCOME = 24.75%

This is a return from June 2009 or about 23 months of about 1.07% per month.

SUMMARY STUDY 2: This is a much better return. However the question arises, how many dividend stock portfolio investors would risk their capital on GE the day after the dividend cut was announced?

STUDY 3: THE INVESTOR WHO BUYS JUST AT THE CLOSE OF THE DAY AFTER THE ANNOUNCEMENT

The investor buys 100 shares at the close on MAR 2 2009 at $7.60 = $760.00

TOTAL INVESTED - $760.00 / 100 shares = $7.60 average cost - sold today at $19.47 = $1187 gain = 156.18% gain.

TOTAL RETURN WITH DIVIDEND INCOME = 168.02%

This is a return from June 2009 or about 23 months of about 7.30% per month.

SUMMARY STUDY 3: This is of course the best return. However this would appear to be more a trader's style and not the realm of a dividend investor who buys for the dividend and holds long term.

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SUMMARY

There are many different strategies that could be applied to this trade. But when analysts comment about buying dividend stock after a dividend cut, it depend on the company itself. AIG, Bank Of America and many others have not recovered from their dividend cuts of 2008 and 2009. Even General Electric stock has not recovered. Therefore it would depend on the investor and his willingness to risk his capital on a stock that has already announced it is in trouble by cutting the dividend.

In Part 2  I look at the long term investor who takes the approach that a dividend cut and the decline in the stock is actually an opportunity for further investing, despite the possible damage which it may have done to his dividend stock portfolio.

INDEX

Dividend Stocks That Cut Dividends

PART 1 - Are They Good Buys?

PART 2 - The Long Term Dividend Investor

PART 3 - Strategies For The Dividend Investor

PART 4 - Buying Puts For Protection