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When Growing Dividends Become Bad

There are 30 companies in the current incarnation of the Straits Times Index (SGX: ^STI) and all pay a dividend.

But, you would be hard-pressed to find a blue chip within the index that has managed to increase its dividend consecutively over the past 10 years with Jardine Matheson Holdings (SGX: J36) being the only company to have such a record. And, the reason that’s so is because the other blue chips have seen their dividends gyrate along with the ebb and flow of their profits.

While it’s always nice to have growing dividends all the time given its importance in generating long-term returns for investors, it turns out that having companies that know how to adjust their dividends with the changing seasons might not be such a bad thing after all.

According to my American colleague Morgan Housel’s latest article titled What American Companies Get Wrong When Paying Dividends, American companies seem to have a collective fixation with maintaining or growing their dividends no matter the cost (which includes borrowing money and/or selling assets). It’s a relatively recent phenomenon that came into being within the last three decades.

Morgan cited the American insurer AIG as a particularly striking example of a company having a dividend-fixation: In 2008, despite making tremendous losses that equalled the combined profits it had earned in the previous 18 years, the firm continued hiking its dividend. The excuse given by AIG’s chief executive, Martin Sullivan, was that “the dividend increase is a reflection… of management’s long-term view of the strength of the company’s business.”

So much for management’s confidence in the strength of AIG’s business when its profits of US$3.15 billion over the last 12 months is less than half of the US$8.11 billion it earned a decade ago in 2003.

In any case, for Morgan, the net-effect of all that unhealthy obsession with steady dividends was two-fold:

1) The portion of earnings that American companies are paying out as dividends now stand at a historic low as companies would likely want to create a buffer to maintain steady dividends in the face of volatile earnings. This can be a disservice to investors as they could be getting higher dividends otherwise.

2) The ostensibly stable dividends in-spite of volatile earnings can be a “false sense of security, which skews people’s perception of risk”.

The second point is important to note for investors everywhere, and perhaps especially in Singapore. While I might be proven wrong, our markets here are a popular destination for real estate investment trusts and business trusts because of higher investor interest. These trusts generally have much higher yields compared to other shares in the market and points to how local investors here like their dividends high.

And, Morgan’s work points to how important it is for investors to focus on the underlying driver for dividends instead of looking at just how a company’s dividend has grown or remained steady through the years. Investors who only saw AIG’s growing dividend instead of its deteriorating business could have been blind-sided badly when the company’s troubles eventually came home to roost.

And just to be clear, stable dividends are not necessarily an indication that a company’s stretching beyond its means. For instance, the local banking trio of DBS Group Holdings (SGX: D05), Oversea-Chinese Banking Corporation (SGX: O39), and United Overseas Bank (SGX: U11) had remarkably steady dividends throughout the 2007-2009 Global Financial Crisis even as Western financial institutions were imploding left, right, and centre (AIG was one of them).

Year

Dividends for DBS*

Dividends for OCBC*

Dividends for UOB*

2005

S$ 0.58

S$ 0.184

S$ 0.60

2006

S$ 0.71

S$ 0.23

S$ 0.57

2007

S$ 0.68

S$ 0.28

S$ 0.614

2008

S$ 0.65

S$ 0.28

S$ 0.6

2009

S$ 0.56

S$ 0.28

S$ 0.6

2010

S$ 0.56

S$ 0.30

S$ 0.6

2011

S$ 0.56

S$ 0.30

S$ 0.6

2012

S$ 0.56

S$ 0.33

S$ 0.6

*Dividend figures exclude special dividends

Source: S&P Capital IQ

On first glance, it might seem fishy that our local banks could be such a bastion of strength even while their Western peers were falling like dominoes. But, as it turns out, the three banks’ weren’t overstretching by any means as their profits managed to hold up really well even during the crisis.

Year

Earnings per share for DBS*

Earnings per share for OCBC*

Earnings per share for UOB*

2005

S$0.54

S$0.40

S$1.11

2006

S$1.50

S$0.63

S$1.65

2007

S$1.50

S$0.66

S$1.36

2008

S$1.26

S$0.55

S$1.24

2009

S$0.90

S$0.59

S$1.19

2010

S$0.70

S$0.66

S$1.70

2011

S$1.30

S$0.66

S$1.43

2012

S$1.57

S$1.13

S$1.72

*Dividend figures exclude special dividends

Source: S&P Capital IQ

All told, growing or steady dividends are great, but it really pays for an investor to look beneath the hood to find out the reason for a company’s dividend history being as it is to avoid taking on unnecessary risks.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.