Investors love dividends, particularly when those payouts are from companies that keep raising their dividends. But what happens when the focus on dividends and return of capital to shareholders becomes too strong? It seems hard to fathom, but some companies may be so focused on dividends and returning capital to shareholders that they are simply gutting their futures.
A couple of things must strongly be considered here before delving into what dividends are safe and which are dangerous. Moody’s has issued a warning that may be years in the making, but corporations and investors better to pay close attention.
Before getting too deep into the Moody’s warning, 24/7 Wall St. wants to offer both sides of the coin and address some of the continued problems about this topic. In this manner, we further addressed some issues that may be behind this trend. Some seem inescapable.
Standard & Poor’s, the top credit ratings rival of Moody’s, recently pointed out that dividends and buybacks combined reached all-time highs in 2014 — with the revelation was that the dividends and buybacks are supposed to grow even more in 2015.
So, what is it that Moody’s is becoming worried about? The credit ratings agency, which evaluates corporate credit profiles for credit/debt investors, is warning that corporate credit quality in investment grade non-financial companies will deteriorate this year. The logic behind this is that the companies are continuing to limit capital investment, while taking on higher leverage and using cash to reward shareholders.
Moody’s is warning that companies are increasing cash dividends today to the point that they are effectively leaving less free cash flow to pay down their debt — even compared to before the recession. It is suggesting that many companies are managing their finances to an interest coverage metric rather than leverage and principal to be repaid.
Moody’s went on to note that debt investors continue to invest, even as corporate credit quality deteriorates and returns decline. The ratings agency feels that this conundrum is creating demand pull, and it worries that the result is inadvertently rewarding companies that are allocating their earnings in ways that actually weaken their credit quality. The ratings agency said:
Prolonged low interest rates have made dividends more important to investors, leaving companies increasingly fixated on dividend growth. But this weakens their credit quality, especially as leverage is rising. … Low interest rates, ample systemic liquidity and bonus depreciation measures mean companies have more cash, but this has been diverted to benefit shareholders instead of investment. Expansionary monetary policies have stimulated credit supply and demand, but capital spending and business investment have not recovered to pre-recession levels, which may portend low future growth.