It’s always a great feeling to receive a dividend from one of your investments.
And it feels even better if that dividend was an increase from the previous year.
However, if the converse happens, most investors are left with a bitter taste in their mouths.
A reduction in dividends may portend worse times to come, or it could be just a one-off blip for the business.
StarHub (SGX: CC3) is a prime example of a company that has reduced its dividend in recent years.
The telecommunication company (telco) used to pay an annual dividend of S$0.20 back in 2016.
Just four years later, in 2020, its dividend has shrivelled to just S$0.05, down a whopping 75%.
The telco used to be a dependable source of quarterly dividends for income-seeking investors, so the cuts came as somewhat of a surprise.
What led to these dividend reductions? Could your stock be the next in line to announce a dividend cut?
Watch that payout ratio
An important factor for dividend investors to consider is not just the dividend yield of a company, but to also assess if that dividend is sustainable.
One tell-tale sign to look out for is a company’s dividend payout ratio (POR).
The POR is defined as the proportion of a company’s earnings that are paid out as a dividend and is calculated by taking the dividend per share divided (DPS) by the earnings per share (EPS).
Most companies pay out anything between 10% to 50% of their earnings while retaining the rest for reinvestment to grow their business.
Some may pay out close to 80% to 90% of their earnings as they have no other use for the cash.
However, red flags arise when a company starts paying out more than 100% of its earnings as dividends.
When this happens, it implies that the business is dipping into its cash reserves just to afford the dividend.
For StarHub, the writing was on the wall back in 2016 when its reported diluted EPS was S$0.197.
With a DPS of S$0.20, this meant that POR for that year stood at 101.5%.
The same thing happened again the following year, with the telco paying out $0.16 in annual dividends while generating a diluted EPS of just $0.141.
A business under pressure
A persistent decline in revenue and net profit can also result in a dividend cut.
Businesses under pressure tend to generate lower levels of cash, which limits their ability to maintain their dividends.
Using StarHub as an example again, its operating profit and net profit had both declined sharply from 2016 to 2020.
Operating profit and net profit stood at S$425.1 million and S$341.4 million, respectively, back in 2016.
By 2020, operating profit had declined by 45.6% to S$231.3 million while net profit had plunged by 53.7% to S$157.9 million.
Unsurprisingly, dividends also decreased in tandem.
For its fiscal 2021 half-year, StarHub continued to report a 12.3% year on year decline in net profit to S$67.9 million.
Even blue-chip companies may fall victim to dividend cuts due to a decline in net profit.
Sembcorp Industries Limited (SGX: U96) cut its annual dividend from S$0.08 in 2016 to S$0.04 in 2020.
From 2016 through to 2020, the group’s revenue fell by 31.1% to S$5.4 billion while its net profit dived by 60.2% to S$157 million.
A boost to net profit
Some businesses may also experience a sudden boost to revenue and net profit resulting from an event or corporate action.
Due to this event, dividends may be temporarily elevated due to the company adhering to a specific POR.
A recent example is that of supermarket operator Sheng Siong Group Ltd (SGX: OV8).
The group experienced a surge in buying activity as lockdowns and movement restrictions kicked in last year.
Net profit for 2020 surged by 83.7% year on year to S$139.1 million, and the group declared an interim dividend of S$0.035 and a final dividend of S$0.03.
As demand normalised, the group announced a 12.1% year on year decline in net profit for 1H2021.
Its dividend was subsequently lowered to S$0.031 compared to the prior year’s S$0.035.
Get Smart: Staying vigilant
It pays to stay vigilant if you want to assess if your stock may cut its dividends.
The above reasons are some of the signs you can watch out for.
While a dividend cut is never pleasant, you need to decide if it may be better to move on to a better investment or stick with the company to see if its dividend can recover.
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Disclaimer: Royston Yang does not own shares in any of the companies mentioned.