Why Dividend Aristocrats Can Be Risky in a Bear Market

One of the most popular income investing strategies is to buy the “Dividend Aristocrats,” those few companies that have increased their dividends every year for 25 years or more.

You’d think this strategy would work especially well in a recessionary bear market, when such an impressive track record would make these companies particularly attractive.

[ad#Google Adsense 336×280-IA]Indeed, the most aristocratic of them all, The Procter & Gamble Co. (PG), has increased its dividend every year since 1954. It has bumped the payout 278% just since the turn of the century, a period in which prices have only risen 40%.

Yet recessions carry a huge hidden danger for the Aristocrats.

Avoid the Pitfalls

The problem is that Dividend Aristocrats are a walking example of survivorship bias.

In economic upswings, almost all of the Aristocrats increase their dividends as advertised. But in downturns, some of them falter – and the returns on those that falter are generally very poor, dragging down the returns of Dividend Aristocrats as a whole.

Like all investing formulae, the Dividend Aristocrat method has a distressing tendency of “reverting to the mean” – there are no free lunches, after all.

To see how this occurs, just look at Pitney Bowes Inc. (PBI), the postage meter company. Going into the 2008 recession, PBI was a fine Dividend Aristocrat boasting more than 30 years of dividend increases.

During the recession, the dividend sometimes exceeded the company’s earnings, which can’t continue for long. Nevertheless, the company continued increasing the dividend while hoping that things would pick up. They didn’t, and in 2013 the company was compelled to halve the quarterly dividend.

Pitney Bowes is still profitable, and the $0.1875 quarterly dividend is still being paid, giving the company a yield of 4% (and a price-to-earnings ratio of only 9.7 times, at current earnings, which still haven’t fallen out of bed).

However, if you’d held the stock since 2007, you’d have lost more than half your capital and would’ve seen your income almost halved, too.

It’s Electric

Over a long period with multiple recessions, there are enough Pitney Boweses amongst the Aristocrats to balance out the superior returns of the Procter and Gambles.

Today’s list of Aristocrats is no exception – it includes several potential Pitney Boweses just waiting for the next recession to shake them off their perch.

One is Diebold Inc. (DBD), the provider of ATMs and security services.

Now, DBD’s dividend track record is second only to Procter and Gamble’s. But DBD’s trailing four quarters earnings is just $1.09 compared to its current annual dividend of $1.15. Plus, its total liabilities are nine times its tangible net worth.

Thus, rather than buying the whole basket of Aristocrats, it may be worth picking and choosing the best companies. Even in a market and economic downturn, some of the Aristocrats remain attractive.

Emerson Electric Co. (EMR), for example, is in something of a dip right now because this electrical equipment company is a substantial seller to oil and gas industries.

However, its dividend has increased every year since 1957 and it currently yields 4.3%. Even though the year to September 2016 is expected to be a poor one, with earnings down 28%, EMR’s dividend will still only be 65% of net income, while its debt-to-equity ratio is less than 1.0 times.

It also has the singular virtue of being a Management Aristocrat as well as a Dividend Aristocrat; the current CEO David Farr is only the third to hold that position since 1954 and has himself been in the job since October 2000.

Emerson offers an example of stability both operationally as well as financially, and it should serve you well in a downturn.

Bottom line: The Dividend Aristocrat investment concept is an attractive one, but it can be risky during a downturn.

The wise investor will pick among these rare birds very carefully indeed, and will look for balance sheet solidarity and management stability as well as a good dividend track record.

Good investing,

Martin Hutchinson

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Source: Wall Street Daily