Yesterday's dividend payments do not guarantee tomorrow's dividend payments. On the contrary, if dividends exceed earnings there is a serious question as to whether a company can continue to disburse the same payments to its shareholders. Payout ratios (dividend payments divided by earnings) which are greater than 1 are cause for scrutiny: investors must find reasons to explain how this dividend yield is sustainable.
Unfortunately, owners of stocks which cut dividends might face a double whammy: reduced income and reduced stock prices. The drop in stock prices upon the announcement of a dividend cut is rationalized by academics as a signaling mechanism. Finance professors view a dividend cut as a way for management to express lowered company expectations to shareholders. In short, "money talks" and reduced dividend payouts result in lower income and lower capital gains.
Stock Selection Criteria
Payout ratios well above 1. This is used as a quick measure of dividend stability.
Distressed Altman Z-Scores. Each stock scored in the "distressed" zone according to the Altman Z-score.* This score places companies into three groups: "safe" (Z-score > 2.99), "grey" (Z-score between 2.99 and 1.81), and "distressed*" (Z-score < 1.81). This metric is surprisingly useful for identifying bankruptcy risk in the coming year. Atlman's method of segmenting companies uses fundamental (financial statement) data and market capitalization only. Beyond credit risk prediction, companies with higher Z-scores have been shown to outperform companies with lower Z-scores, in aggregate.
Caution should be applied to the following stocks:
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