- The Profit Zone
- Posts
- How to limit your chances of a dividend cut
How to limit your chances of a dividend cut
4 steps to take to ensure your passive income doesn't go down
Welcome to The Profit Zone, where 12,500+ millionaires, CEO’s and high-performing entrepreneurs read the #1 financial newsletter on Substack, providing you with weekly insights on the stock market and tips you can’t find anywhere else.
Happy Monday!
Let’s start the week off strong.
The agenda for today:
👉 $4 bottle of water or $4,000 in the stock market?
👉 Why do dividend cuts happen?
👉 Steps to avoid stocks likely to cut their dividends
Tweet of the Week
Dividend Cuts: A Dividend Investors Worst Nightmare
Picture this…
The year is 2050 and you have $3 million invested in dividend stocks.
You’ve spent the last 30 years of your life consistently buying dividend stocks and reinvesting all of your dividend income.
You’ve made tons financial sacrifices to get to this point.
Your goal was to retire from working for a salary and live off your dividend income, travel with your family and enjoy everything life has to offer without spending 40 hours a week inside a cubicle.
You’re excited to start this chapter of your life, but then…
Dividend cuts decide to ruin your plans.
Your $3 million portfolio that had an average dividend yield of 4%, paying you $120,000/year in passive income, is now paying you only $60,000/year.
“How am I going to live off that?” You think to yourself…
Retirement seems so much further away and you can’t sleep at night.
You debate continuing to work for another few years to make up for the lack of income.
Scary right?
I often think about a scenario like this happening to me as I near retirement.
As I’ve said in the past, retirement isn’t an age, but a number.
The average age of retirement in the U.S. is 64 years old.
The average life expectancy is 77 years old.
You’re telling me that I need to work until I’m 64 years old to enjoy the next 13 years of my life?… No thanks.
This is why we buy assets that generate cash flow.
So that every $1 we have invested is $1 closer to our passive income goals.
But the reality is, dividend cuts are out of our hands.
It’s a management decision and unless you’re part of the management team, your income is at the mercy of the company and its performance.
With that being said, there are a few steps you can take to help minimize the chances of a dividend cut, and if it does occur, to minimize the impact it has on your passive income.
Let’s dive into it…
Why do dividend cuts happen
Dividends are cash (sometimes stock) payments to shareholders that are paid out from their excess earnings.
Many younger companies don’t pay a dividend because it’s more beneficial to shareholders that the company retains its earnings and invests them back into the business in hopes of future growth.
But mature companies, those that have been profiting off their customers for years, have expanded geographically and have loyal buyers who keep coming back for more, may not need all of the profits they earn.
That’s when companies decide to start paying a dividend. And in my opinion, the pros that come from the decision to start paying a dividend far outweigh the cons, but that’s a conversation for a different time.
Companies will decide to cut their dividend because they no longer have the cash on hand to continue to support their daily operations while also paying shareholders.
There are a variety of reasons why dividend cuts might happen, here are a few notable ones:
An existing product line sees a decrease in demand
An increase in the price of materials
An increase in the price of logistics
An acquisition or merger that costs the company too much money
Just to name a few.
As dividend investors, the best thing we can do is lower our chances of experiencing a dividend cut.
Here’s how you can start doing it yourself:
Profits, not debt.
A big warning sign with any dividend paying company is when they’re paying out dividends from debt.
Borrowing money to pay out shareholders is a red flag.
The reason is simple: if the company were to see a decline in revenues and are unable to keep up with their debt obligations (payments of interest), creditors will start demanding their money.
Once that happens, and if the dividend is being paid out via debt, you can be sure that your dividend will likely get cut, or even worse, eliminated.
The Dividend Payout Ratio
The dividend payout ratio provides investors with an inside look at how much the company is paying out in dividends relative to their earnings.
When it comes to payout ratio’s, I like to buy companies in the 35-55% range.
This is personal preference however I’ve found that this range provides dividend investors with a good chunk of cash flow while the company also maintains some wiggle room for internal investment and the possibility of increasing dividends in the future should they choose to do so.
You NEVER want to buy companies with a 100%+ payout ratio.
Red flag.
This signals that every dollar the company generates in earnings or free cash flow is paid out to shareholders, leaving absolutely no margin of safety for the business itself.
Buy Stocks That Have Been There Before
“Past performance doesn’t guarantee future results”
While this may be true, dividend stocks provide somewhat of an exception to this rule.
Why?
There is a list of dividend paying companies called The Dividend Aristocrats that is an elite group of companies who have increased their dividends for 25+ consecutive years.
Additionally, there’s an even more exclusive list of dividend paying companies called The Dividend Kings who have increased their dividends for 50+ consecutive years.
These are stocks that were able to continue raising dividends through wars, pandemics, recessions and political turmoil, which provides dividend investors with a level of confidence in their future cashflow.
Invest in dividend paying companies that came out on the other side unaffected by anything going on around them.
Determine the Financial Strength of the Company
You can probably look at someones bank statements and determine if they can cover their bills for the next year in the event they got laid off from work and had no income.
The same goes for a business.
As the great Warren Buffett once said “never invest in a business you cannot understand”
As dividend investor, it’s important to analyze a businesses expenses, debt obligations and revenue to determine the probability of that company surviving should things go south.
It’s also important to determine if a company has the ability to redirect some of its resources to continue paying a dividend. There have been businesses in the past that have pushed back scheduled investments to free up extra cash to pay shareholders.
Ensure that the businesses you’re analyzing can do the same if push comes to shove.
Final notes…
Analyzing dividend stocks can be hard.
So I made it easy.
For a limited time, you can grab The Complete Investors Accelerator Pack for 50% OFF.
Inside, you will learn all of the tricks to ensuring the chances of you experiencing dividend cuts are minimized.
Specific ratio’s to look at
How to read a cash flow statement
What increases the probability of dividend hikes
And much more.
Click below to get your copy 50% OFF.
Limited to 20 copies (first come first serve).
Alex (The Dividend Dominator)Founder and CEO of Dividend Domination Inc.
Advertise with Us
Do you have a business that needs some more exposure?
Want to get more eyes on your products?
Advertise to 12,000+ investors with this newsletter who are hungry for financial content.
Or advertise on our Twitter and Instagram.
Click here to book with us.
Some resources to help you make more money:
My Website - a one-stop shop for all things dividend investing.
Financial Domination - learn how to set up an effective budget, choose the right broker, figure out your investing strategy, use stock screeners to filter out the garbage and more. Everything I wish I knew when I first started investing.
The Complete Investors Accelerator Pack - everything you need to build a dividend portfolio that grows on itself. Learn more about dividend investing, how to analyze dividend stocks, what to do with your dividends and how to build a stream of passive income through the stock market.
Ca$hing in on Twitter - start building a following on Twitter and learn how to monetize it. Turn Twitter into your own personal cash-flowing asset that will pay you while you sleep.
My Full Stock Portfolio - get access to all of my positions and get updates every time I buy or sell.
Money Mastermind - the “Money Bible”. Myself and 29 other expert creators teamed up to create the most all-inclusive 280-page finance book on the market. Over 100 topics about money including real estate, crypto, budgeting, dividend stocks, online business, and more.
TweetHunter - let the software do the tweeting for you. The only scheduler you’ll ever need. This tool makes me money in my sleep. Give it a try for free.
Hipster Budget Guide - having trouble saving money? Learning how to budget is your solution. This book will show you ways to save money you never even thought of. Worth every penny.
Reply