Dividend Increases Are Slowing And The Cuts Keep Coming

We’ve said it often. A good dividend is getting harder and harder to find.

During the first two months of 2016, just 84 companies raised their dividends, compared with the 106 that did during the same time period last year.

What’s more, those companies that have increased their payouts have done so to a lesser extent. The average boost has been 10%, down from 13% in 2015 and 18% in 2014.

Companies are becoming less eager to dole out cash to shareholders in today’s uncertain economic environment.

While the lack of dividend growth is certainly something we’re paying attention to, dividend cuts and suspensions have been the bigger news. Companies operating in the commodities and industrial sectors have been the hardest hit.

It’s not just a small company problem either. ConocoPhillips’ (NYSE: COP) massive 66% dividend reduction last month proved that the larger companies are not immune to the unprecedented fall in commodities prices.

It will help us understand why we’re seeing such widespread dividend slashing if we look first on a smaller scale.

Why Do Dividend Cuts Happen?

A dividend cut is an act of last resort for a company.

When a company cuts or, worse, eliminates its dividend, it is admitting to investors that its financial position is weakening and its management does not expect that financial position to improve anytime soon.

Dividends are paid from free cash flow. When cash flow declines, the company’s payout ratio (dividends paid divided by cash brought into the business) climbs. When the payout ratio tops 100%, the company cannot self-fund the dividend anymore. It is paying out more cash in dividends than the business is generating.

In that case, in order to continue paying a dividend, management must find alternative sources of funding. For short-term blips, a company may decide to dip into cash reserves. Other times, a company may choose to cut costs and capital expenditures or issue debt to meet past dividend levels.