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The Impact of Covid-19 on Equity Dividends

The pandemic has had a significant impact on the dividend policies of companies around the globe. In the following Q&A, we discuss how these changing dividend policies may affect investors and the potential implications for their portfolios.

Dividends: Current state

Q: Why do companies pay dividends?

Dividends are payments made by a company to owners of the company’s stock in the form of cash or additional shares of stock. Companies are not required to pay dividends but do so for multiple reasons, such as rewarding shareholders for providing capital to run the business and attracting additional investors as consistent dividend distributions signal financial strength. Given that investors broadly expect that dividend distributions will remain stable or increase over time, dividend payments encourage companies to be disciplined in their decisions to reinvest, retain, or distribute cash.

Q: Why are dividend-paying stocks attractive to some investors?

Dividends can be attractive to investors who focus on a stock’s total return (i.e., share price appreciation plus dividend income), as dividends can play an important role in supporting a stock’s long-term appreciation. Dividends can also help reduce a stock’s return during bear markets, as dividend distributions historically have been less volatile than stock prices.

Dividends also enable investors to realize a cash return from an investment without having to sell shares, which can be attractive to certain investors who focus on the income produced by an investment portfolio. Some investors may see dividend-paying stocks as “bond proxies,” particularly in low-interest-rate environments – though we would note that even dividend paying stocks are a more risky and volatile component of the portfolio, and should not necessarily be viewed as a substitute for fixed income in a balanced asset allocation.

Q: Why are companies adjusting their dividend policies in recent months?

The pandemic has upended the global economy, shutting down factories, stores, restaurants, and non-essential services, resulting in a direct hit to many companies’ earnings. In response, some companies have adjusted their dividend policies for various reasons, including:

  • Cash preservation. Some companies under financial stress will eliminate or reduce dividend payments in order to preserve cash to protect solvency, while others under less stress may choose to retain cash on the balance sheet to ensure access to capital in the future.
  • Regulatory requirements. Policymakers may require companies that have received government assistance to suspend dividend payments. For example, the Paycheck Protection Program in the U.S. can prohibit participating companies from paying dividends under certain conditions. The European Central Bank and Bank of England urged financially sound banks to suspend dividend payments in order to preserve lending capacity and to prepare for potential loan defaults related to the pandemic and subsequent economic contraction.
  • Perception. Companies may not wish to be seen as using resources to reward investors at the same time that they, or their peers, are furloughing or laying off employees.

Q: How many companies have already canceled or suspended dividends?

How many companies have already canceled or suspended dividends?

Source: Bloomberg, data as of 13 July 2020.

Q: How does the current environment for the markets and dividends compare with the Global Financial Crisis of 2008-2009?

The Global Financial Crisis (GFC) of 2008-2009 led to the largest volume of dividend cuts and suspensions since the Great Depression. By mid-2009, 34 companies in the S&P 500 either discontinued or omitted dividend distributions.

Vanguard’s dividend-focused index funds were impacted by the GFC. The number of holdings in our US-domiciled dividend appreciation portfolio fell from about 210 to about 180 following the GFC, while our high dividend yield portfolio saw holdings fall from about 575 to about 500. Since the GFC, the number of holdings in the latter has continued to decline as companies have increasingly opted to return cash to investors through share buybacks rather than dividends.

Expectations for the markets

Q: What are Vanguard’s expectations for corporate dividends over the coming years for US stocks?

Over the first half of 2020, a relatively high number of companies have adjusted their dividend payout policies. The impact of these changes has already affected the dividend per share of some of our equity funds (particularly those with ex-US exposure). Looking ahead, we believe that further dividend cuts are likely. However, it is difficult to predict what will follow given the high level of uncertainty around the economy and public health. Regional and sector nuances further complicate expectations for widespread dividend reductions. A prudent way to approach expectations for dividend policies going forward is to evaluate the dividend practices of companies, as well as regulatory considerations, bearing in mind that dividend policy practices may vary by country.

In the US, while further cuts to dividends are possible and perhaps likely, the magnitude of dividend cuts may not be as broad or deep as the economic situation may suggest.

First, U.S. companies generally balance two methods of returning cash to shareholders: dividend distributions and share buybacks. Unlike dividends, investors generally do not expect that share buybacks will continue at a regular pace or magnitude, allowing companies that need to retain cash to forego buybacks rather than eliminate dividends. Many companies did just that during the GFC, when share repurchases fell at a greater rate than that of cash dividend payments.

Second, the sector composition of dividend payers has shifted over time. Prior to the GFC, financials and energy companies represented a large portion of dividend paying companies (but not necessarily dividend-increasing companies). Since then, information technology and health care companies – often characterized by stronger balance sheets and less sensitivity to the particular type of market and economic uncertainty being caused by the pandemic – have come to represent the largest sectors of dividend paying companies and may be better able to endure the current environment.

Q: What are Vanguard’s expectations for corporate dividends over the coming years for non-US stocks?

Outside the US, dividend policy practices differ by region. Companies in Europe and the UK may be more likely than US or Asian companies to see broad and/or deep cuts to dividends, as they tend to pay out a higher portion of earnings to investors in the form on dividends. Given that most firms don’t return cash to shareholders through both share buybacks and dividends, dividends will be the main lever companies can pull to retain cash.

Further, regular dividend payments by European companies require shareholder approval, which is solicited during a company’s annual general meeting. Due to lockdown conditions being imposed around much of the world, many companies have had to postpone their annual meetings, resulting in omitted or discontinued dividend payments.

The sector composition of the dividend environment is important as financials and energy companies represent a large contingent in Europe. This could pose a headwind to dividend distributions in Europe as many banks are facing significant regulatory pressure to reduce dividend payments.

In the Asia Pacific region, companies tend to hold higher levels of cash than European firms, so the reduction in dividends from the current baseline may not be as widespread.

Q: What sectors have been most affected by dividend cuts?

Across the globe, the market expects reduction in dividend payments to be concentrated in the industries that do not have a large technology presence or those that rely primarily on physical presence to conduct business. Most dividend discontinuations and omissions thus far have been concentrated in the consumer discretionary sector, as automobile, retail, media and entertainment, and travel and leisure companies have been hit hard. Industrials have also been impacted with transportation companies representing a large portion of dividend cuts. Energy companies are and could continue to be vulnerable given the selloff in commodity prices. Finally, as mentioned previously, European banks may continue to face regulatory pressure on dividend payments.

Q: What are some factors that may encourage companies to continue paying dividends?

Regardless of region or industry, many companies may be able to, and seek to sustain, dividend payments for various reasons, including:

  • Maturity. Companies that consistently pay and increase their dividends tend to be more mature, have dominant or niche positions in their industry, have relatively less volatile earnings, relatively high returns on assets, and relatively low debt ratios. These attributes are characteristic of companies with strong balance sheets that often have the ability to navigate economic downturns without altering the dividend policy.
  • Income proxy. Companies recognize that many investors consider dividend paying stocks as bond proxies given the extended period of low interest rates on many fixed income securities since the GFC.
  • Signaling. Many analysts believe that dividend omissions or discontinuations signal financial stress, reduced confidence in management, and future earnings problems for a company. Managers are aware of these beliefs and often take steps to maintain dividend payments in order to avoid these negative signals.

Q: What should investors do?

As ever, we hold to our principles for investing success. Discipline, especially, is essential in times such as these. Investors who abandon their well-considered, long-term financial plan rather than staying the course through a recovery could cause themselves lasting harm. Investors mostly have experienced gains for the last decade; it’s important to remember that equity markets are filled with ups and downs, but have rewarded investors over the long term.

Originally Posted on August 10, 2020 – The Impact of COVID-19 on Equity Dividends

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