A dividend can actually be a huge red flag depending on where the company gets the money for it. If you know what to look for, a company paying or increasing its dividend is not always a good sign.
How does your favorite dividend paying company get the money for those annual or quarterly payments? Have you seen the statement of cash flows and income statement? Do you bother to dig deep to learn as much as you can about the companies that you are investing in?
You definitely should take the time to understand where the money is coming from. You need to know the balance sheet, statement of cash flows, and income statement inside and out of companies you potentially want to invest in.
Anything less than thorough due diligence can leave you vulnerable. Here are two examples of companies issuing or increasing their dividend when they possibly should have considered other options.
Rising Dividends And Sinking Revenue
Investors love stocks that offer a dividend in both good times and bad. Dividends typically show investors that a company is financially sound and has the resources to pay out a portion of its proceeds back to its shareholders. But, what happens when companies continue to issue dividends when revenue or profits are starting to lag? It is a red flag when a company raises dividends despite lower revenue or profits.
For example, FLIR Systems (Stock Symbol – FLIR), the makers of night vision and infrared devices primarily for the US military recently raised their quarterly dividend by 17% despite its sales missing their Wall Street predictions this quarter by over $200 million. Even though revenue was down, the company boasted a 9% increase in profits in the fourth quarter almost solely because of operational cost cutting measures. There is only so much cost cutting measures that companies can continue to make before they reach the limit, and increasing their dividend even while revenue is slumping is not helping.
Borrowing To Pay For A Dividend
Publically traded companies can often find a better use for the cash on their books rather than using the money to increase dividends while they have high debt loads. In most cases, paying dividends if they are still adding to their long-term debt can eventually lead to trouble.
Companies are essentially borrowing funds to pay dividends to their shareholders instead of retiring its debt. For example, KB Home (KBH) has a dividend yield of 1.9%, over $900 million in cash on the balance sheet, and almost $1.8 billion in debt. KB Home continues to issue and increase its dividend despite the trying housing market and its debt load.
If investors are not careful, there is a potential for company executives to manage their earnings in order to continue to pay dividends and increase their dividend payouts by using debt to the detriment of their long-term shareholders.
The Bottom Line
Most investors love dividend paying stocks because they are typically large, blue-chip companies with slow and steady growth. Dividend paying companies provide a bit of comfort, safety, and conservatism to an investor’s portfolio. But, dividends are not always what they seem.
There is an incredible pressure on corporate executives to continue paying dividends, to keep increasing dividends year in and year out, and keeping up the appearance of a healthy dependable company. Investors can be at risk if you do not dig deeply into how companies are continuing to raise their dividends and make payments in both good times and in bad and fluctuations to their revenue and profits.
What do you think? Is it okay for a company to borrow money to pay its dividend? Should companies continue to raise dividends each year because that is what’s expected of them despite patches of declining profits or revenues?