Hints Of A Dividend Cut

You can often tell when a stock is about to suffer a dividend cut before the announcement is made.

British Petroleum was on the front page of the Deepwater Horizon oil rig catastrophe and can be used as a good example to illustrate how you can be forewarned.

Before we start this story I need to clarify one technicality for U.S. investors. BP is a foreign company so when I say “stock” I am really talking about ADRs (American Depository Receipts) which is what foreign companies use to trade on U.S. stock exchanges. Not really important right now to understand the difference.

The story starts with British Petroleum (BP) being an excellent dividend stock. Its price prior to the accident was fluctuating between $55 and $60 per share.

The company had increased its dividend distribution for over 10-years and was paying about $3.36 per share resulting in a 6% dividend yield. What a great dividend stock!

BP’s stock fell below its 200-day moving average about one week later. The 200-day moving average was at about 55 at the time.

At this point news articles were not quantifying the severity of the disaster. Nor were they reporting any details regarding the financial impact to the company. The public did not know.

Over the next several weeks there were daily and weekly articles about how long it would take to stop the leak, the financial impact to the company, and the company’s viability.

There were articles on both end of the spectrum. Some claimed the disaster would be end up having a minimal financial impact considering the company’s financial strength and breadth, and that the company’s dividend would not be affected.

Some news reports predicted the company’s eventual bankruptcy.

The stock's price continued to fall. As it did, the dividend yield climbed. Remember the dividend was $3.36. The dividend yield climbed to 8% as the stock price dropped to $42. The dividend yield climbed to 10% as the stock price fell to $33.

The company announced on June 16, 2010 that it was suspending its dividend. At that point the stock price was about $31 per share.

Two Lessons

An unlucky investor who had invested in the company by buying 100 shares right before the accident because of its excellent 6% dividend yield would have paid about $5,700 (assuming $57/share which is the middle of the range).

A savvy dividend investor had two indicators that this stock was headed for trouble.

First, the stock fell below its 200-day moving average. This technical support is a very large signal in the trading world. You must pay attention to it. The trend following investor would have sold his shares when the stock’s price fell below the 200-day moving average he would have sustained a $700 or a 12% loss (the moving average was at 55, but I assumed the investor sold his shares at $50 which was the stock’s price at the end of the week which I believe realistically accounts for individual investor response times).

The buy and hold investor would be currently sitting on a $2,600 or 46% loss. And no dividends.

At this point he is left with two options:

1. Take his 46% loss by selling his shares, or
2. Continue to hold his stock and hope the stock eventually recovers. He cannot count on dividend distributions to recover his losses. He needs the stock to climb 80% to break even.

The other lesson is that a rising dividend yield is often a danger signal, especially for mature, stable companies like BP. Dividend investors should be skeptical and cautious anytime a stock's dividend yield is significantly out of line with the industry norm. It could be a really good value investment opportunity. Or it could be the early warning signal of an impending dividend cut. Only your due diligence will determine the true story.

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