Are Dividends in Dire Straits?

Many companies, especially banks, have had to slash or eliminate payouts. How low will dividends go?

By Ben Steverman

Companies continue to slash dividend payments to shareholders, as firms rush to hold on to capital amid the continuing credit crisis and deteriorating economy.

The latest to slash its payout is financial firm State Street (STT), which on Feb. 5 dropped its quarterly dividend from 24¢ to 1¢ per share. On the same day, auto and truck dealer Penske Automotive Group (PAG) suspended its dividend.

In the past two months, corporate boards have cut dividends by half or more at Macy's (M), Pfizer (PFE), and Constellation Energy Group (CEG). Dividends have been eliminated—or nearly so, with payouts slashed 96% or more—at Bank of America (BAC), Motorola (MOT), and Citigroup (C).

The trend is disturbing to investors, who especially appreciate dividends at times of economic uncertainty.

"Investors are really looking for yield, and they're looking for safety," says Bruce Bittles, R.W. Baird's chief investment strategist. "Companies that cut their dividend take away both."

Howard Silverblatt, Standard & Poor's senior index analyst, says actual dividend payments by firms in the S&P 500 index plunged 23.9% in January. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).) "It's going to be a bad dividend year," he says, predicting 2009 will be "the worst in at least 50 years."

Financial Crisis Is a Huge Blow

Thanks to the financial crisis, it's no surprise that many of these dividend-cutters are banks. To make up for large losses and shore up their capital, financial firms aren't just cutting dividends but also taking federal government bailout money.

"The financial sector has been stripped of [its] dividends," says Daniel Peris, a portfolio manager of the Federated Strategic Value Fund (SVAAX). That's a huge blow to dividend-focused investors, because the financial sector traditionally made up a quarter to a third of the dividend income from the U.S. stock market.

Dividend cuts may actually be a positive for already-battered financial firms. For many banks with strained finances, "it seems to be a better management move to not pay your dividend," says Standard & Poor's equity analyst Stuart Plesser. A dividend cut can help avoid other less attractive options for raising cash, such as issuing new stock, which dilutes current shareholders' stakes. "It's the lesser of two evils," Plesser says.