Dividends have been a silver lining for the stock market this year, but investors are grappling with whether they can keep up such a rapid pace of growth.
Companies in the S&P 500 (.SPX) have spent nearly $421 billion on dividends through November, a record-setting sum that eclipsed last year’s mark of roughly $391 billion and the full-year tally of $420 billion, according to S&P Dow Jones Indices (.DJI). More than two dozen companies announced additional dividend increases so far this month, which will push the year’s total even higher.
Those payouts are easing investors’ burden as they navigate a challenging investment environment. The S&P 500 is on pace to fall 2.8% this year for its first annual loss since 2015, as concerns including a trade spat with China, Federal Reserve interest-rate increases and a sharp drop in oil prices point to the potential for an economic slowdown.
But an index that measures the S&P 500’s total return, which includes dividends, is roughly flat in 2018 after more than 300 companies in the broad index increased or initiated payouts this year.
It is the latest benefit of a surge in company profits that was precipitated by last year’s sweeping corporate tax cut. The earnings boost was a one-time catalyst though, and with just two weeks left in the year, investors are bracing for a pullback in profit growth that could lead companies to hold their dividends steady, or even cut them, in the months ahead.
“There was a confluence of a couple of things that contributed to dividends that won’t happen again,” said Jim Tierney, chief investment officer of concentrated U.S. growth at AllianceBernstein. “Far more companies brought their dividends back and were more comfortable paying that higher dividend, driven by earnings growth.”
Without the corporate tax cut as a stimulus, profit growth is projected to drop by more than half next year, with FactSet projecting an 8.3% earnings expansion rate, down from nearly 21% this year.
That could put corporate profits in a tight spot if trade tensions heighten next year or economic growth slows, potentially forcing some company boards to consider halting their dividend increases or worse—trimming them.
Companies that are more leveraged may take a pause, said Tony DeSpirito, BlackRock Inc.’s head of U.S. fundamental active equity, adding that businesses with more predictable, consistent cash flows will have better odds of keeping up their pace of dividend increases.
For now, analysts are forecasting another potentially banner year for dividends in 2019, assuming profit growth ends up at around current projections. Dividends are projected to increase as much as 6% next year, albeit slower than the 9% growth rate in 2018, putting the payouts north of $500 billion, according to Goldman Sachs .
Helping those projections is the fact that companies are putting a smaller percentage of their net income toward dividends thanks to the corporate tax cut, giving them more room to work with. S&P 500 companies reported a dividend-payout ratio of roughly 33% as of mid-December, down from about 38% at the end of last year, according to FactSet.
“Can the pace of dividend growth continue? Not a chance,” Mr. Tierney of AllianceBernstein said. “Will the level of dividends continue? Maybe, but certainly not the rate of growth.”
Take industrial distributor Fastenal Co. (FAST) Strong earnings and a robust flow of cash thanks to the tax overhaul led the company to raised its dividend twice this year, once in January and again in July, boosting its dividend yield to 2.9% from 2.3% a year earlier.
But Fastenal’s operating outlook darkened in October when company executives told analysts that some of the tariffs the U.S. enacted on imports were directly hurting its customers’ supply chains in North America, compressing its margins.
“We don’t know what the next leg is going to be,” Chief Executive Daniel Florness said at the time in response to a query about whether margin pressure will continue in 2019. “We don’t know if we’re going to be sitting here in March and 10% [tariffs] is at 25%…or 10% is at 0%.”
Fastenal’s shares are down 1.5% for the year but up 1.4% on a total-return basis. A company executive didn’t return a message seeking comment.
Dividend cuts can be devastating for a stock price as they can signal to investors that a business may not be as healthy as thought.
General Electric (GE) shares, for example, fell precipitously after the ailing conglomerate cut its quarterly dividend to a token penny a share in October. The stock is down nearly 60% for the year, on pace for its worst-ever annual performance.
That is why even companies that perennially hike their dividends have warned against overdoing it.
“Every seven years, don’t increase it,” said JPMorgan Chief Executive James Dimon at a Goldman Sachs conference earlier this month, even though the bank has raised its dividend eight consecutive years since 2010. “I’ve seen company after company get crippled over this every year.”
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