Last Updated on March 31, 2021 by Oddmund Groette
Dividend investing has become increasingly popular over the last decade. One of the main reasons is the belief that investors don’t need to worry about sequence risk and a bear market: dividends drop less than the share price.
In this article, we look at what happens to dividends in a bear market and how dividends correlate to the share price.
What happens to dividends when stocks go down?
The stock market and the dividends are two separate things. Mr. Market has frequent mood swings: sometimes he is depressive, and sometimes he is exuberant. The market discounts news in just minutes and hours, while a company’s dividend policy rarely gets adjusted. As such, there can be a complete disconnect between the share price and the dividends.
Changes in share price don’t influence the dividend, but recession, fundamentals, and management policies do. In the long-run, there is, of course, a strong correlation between a company’s fundamentals and its dividends.
Historical dividends per share:
The total amounts paid out in dividends have gone down at intervals, albeit slowly rising together with rising share prices. The graph below shows the dividend per share from 1871 to 2020:
The above chart is not logarithmic. If we use a logarithmic chart, the growth during the last ten years is dramatic compared to earlier. Is this sustainable? Only time will tell. Much of the market-cap has gravitated to just a few companies.
Correlations between the share price and dividends:
We made a simple monthly correlation between the S&P 500 and the dividends per share:
The correlations are based on monthly prices. The blue line is one-year rolling correlations, the red line is two-year rolling correlations, and the blue line is three-year rolling correlations. Clearly, in times of turbulence, the correlations break down. However, there is always a lag between the share price and subsequent fall in dividends.
This table below goes further back in history:
Share prices recover faster than dividends per share?
The share prices recover faster than dividends. Why is that? That is because the share price reflects the future cash flows. If a company issues a positive profit warning, the share price normally pops up immediately. However, we can expect dividends to react much later and slower to changes in fundamentals:
The Blue line is the annual rolling one-year change in the share price, while the red line is the annual rolling change in the dividends per share. The share prices are much more volatile, while the dividends are much less prone to dramatic swings. Furthermore, the share price reacts much faster while the dividend reacts slower. This is particularly apparent during the GFC in 2008/09: The share prices dropped a lot while the dividends were reduced later:
The S&P 500 reached its bottom during the GFC in early March 2009, while dividends per share bottomed much later in 2010. At that time, share prices had already recovered substantially.
Why do dividends drop less than the share price?
The main reason is most likely that management teams don’t want to reduce or cut the dividend. One of the last things management wants is to reduce the dividend. To keep the dividend, or even raise it, is seen as a “commitment” to shareholders. The saying is that this “rewards” shareholders. As long as the business model is intact and the debt covenants are not threatened, the dividend is not likely to be cut or reduced.
We tend to be skeptical. There are many good reasons why a company should reduce its dividend and why it’s beneficial for shareholders. In many cases, shareholders profit from reduced dividend payments. To pay dividends is one out of five ways to spend retained earnings. You can read more here:
Shareholders always have to ask themselves: where does the capital compound efficiently? In your pockets or in the company? Having a quarterly dividend is what happens after you build something great. But it can come at the expense of what made you successful in the first place.
Management would rather borrow to pay the dividend than to cut it
After cutting deferrable investment, firms would borrow money to pay the dividend, as long as they do not lose their credit rating. Next, they would sell assets at fair value and cut strategic investment. Only if all these actions are insufficient, would they resort to a dividend cut.
The above conclusion is from the research team at Deutsche Bank after they asked large companies how they prioritize cash flow in a crunch. This is the same approach ExxonMobil did during both the oil crisis in 2014/15 and the Covid-19.
Dividends are less volatile than share prices and fall less than the share price in a bear market. However, despite this, investors should be agnostic and be careful at looking at stocks as a proxy for bonds. Maintaining a dividend track-record can often become a burden, not a rational capital allocation. Always ask yourself if the capital allocations are rational end effective.
Disclosure: We are not financial advisors. Please do your own due diligence and investment research or consult a financial professional. All articles are our opinion – they are not suggestions to buy or sell any securities.