5 Blue-Chip Stocks Cutting Dividends; How to Tell if a Dividend Is Safe

The year 2020 has not been kind to most investors.

While U.S. Treasury bonds have performed like all-stars thus far, stocks certainly haven't followed suit. Frustratingly, conservative investors who are looking for yield won't find much help in Treasurys. The 10-year is yielding less than 1%.

One frequent place of refuge for these investors has been dividend stocks, which offer much higher yields than U.S. government bonds. But even blue-chip dividend stocks have cut or entirely suspended their dividend payouts in 2020 as the pandemic takes its toll on businesses large and small.

Here's a quick look at some of the biggest companies cutting dividends -- including a handful of blue-chip names -- and, more importantly, a general guide for steering clear of stocks that will cut or cease quarterly payouts going forward.

Blue-Chip Stocks Slashing Dividends

The largest of the blue-chip stocks to entirely suspend its dividend has been aerospace and defense giant Boeing (ticker: BA).

Yes, the company's 737 Max fiasco had been an ongoing nightmare even before the pandemic, but the virus' sudden decimation of air travel came as a double whammy, threatening Boeing's production pipeline and cratering demand for future planes.

In March, the company announced it would be suspending its dividend until further notice, pausing share buybacks and that CEO Dave Calhoun would forego pay in 2020. The company also began angling for $60 billion in government aid.

The day before this announcement, Ford ( F) announced its own dividend suspension.

The legendary American auto manufacturer paid about $2.4 billion in dividends in 2019 and was yielding more than 13% at the time due to a steep sell-off. The company also drew down on more than $15 billion in lines of credit -- the entire amount it had remaining.

Rival General Motors ( GM) followed suit in April. Shares were yielding nearly 7% when the company suspended its dividend and share buyback program, while also utilizing billions from revolving credit facilities. Storied brands and blue-chip perception aside, cyclical parts of the economy such as the auto industry were some of the worst-hit by the pandemic.

It makes sense, too, that Las Vegas Sands ( LVS) was forced to suspend its dividend entirely in April as well. There's no such thing as social distancing at a craps table or roulette wheel, and LVS wouldn't have been doing its fiduciary duty if the casino operator hadn't stopped burning cash with dividend payments. Its lucrative Macao casinos saw revenue decimated in the first quarter, making quick work of a yield that had reached 6.9%.

Another $20 billion-plus company, oil field services firm Schlumberger ( SLB), cut its dividend by 75% in April -- it was yielding around 13% at the time. Combining the move with a broader restructuring of the company, the firm laid off 1,500 workers in North America last quarter as energy prices plummeted among a supply glut and falling demand.

Although there are dozens of examples of prominent companies cutting their dividends recently, the key for investors is to gain some understanding of how best to avoid such situations.

Signs a Dividend May Not Be Safe

So how can you tell whether or not a dividend is safe? Generally speaking, there's a simple checklist of sorts that investors can follow to avoid stocks that are cutting dividends. Here are some key points to consider:

-- Beware of suspiciously high yields.

"The most important thing is to not chase yield," says Christopher Huemmer, senior vice president and senior investment strategist at FlexShares Exchange Traded Funds. "Often that 'too good to be true' dividend yield is just that; [it's] a high yield because of a large price decline due to bad news," he adds. "Make sure you are evaluating the quality of the company alongside the dividend yield."

-- Note a high payout ratio.

While a tantalizingly high dividend yield, as a rule of thumb, tends to be a red flag, a high payout ratio can be even more indicative of trouble. The payout ratio represents the percentage of company earnings a business has been using to pay its dividend alone.

Benjamin Halliburton, chief investment officer at Tradition Asset Management, considers high dividend payout ratios to be 70% or more.

When one of these companies "runs into a poor earnings environment," Halliburton says, "they may not have enough earnings to cover the dividend."

"No cushion can result in down earnings, forcing a dividend cut," he adds.

These companies simply have less margin for error. REITs, for various reasons, can often comfortably have payout ratios above 100%. Barring rare short-term hits to earnings that may skew the payout ratio briefly higher, however, normal stocks should not see payout ratios above 100%. That means a company is borrowing money to pay the dividend.

"Debt recapitalization (borrowing to pay stockholders) worked well during the low volatility, low interest rate environment. Lenders are understandably more cautious today," says Peter Donisanu, chief financial strategist at Franklin Madison Advisors in Pittsburgh.

"Therefore, firms that had relied on debt to issue dividends are likely to see a cut as the credit spigots close," Donisanu says.

-- Check fundamentals: Cash flow, debt, earnings and outlook.

Picking safe dividend stocks to buy, at the end of the day, really comes back to choosing companies with strong fundamentals.

"In terms of evaluating companies that may be in line for a dividend cut, we'd suggest looking at cash flows, debt utilization and payout ratios," Donisanu says.

The outlook is also important, especially in a post-pandemic environment where some companies are seeing their business models and expected future demand changing.

"Avoid a company whose financial health is deteriorating yet is continuing to maintain its dividend," Huemmer says. "Evaluating the profitability and cash flows of the company can give insight that past dividend history does not."

-- Track record is a mixed indicator.

Many investors look for stocks with a long track record of both paying, and preferably, growing, the dividend.

It makes sense that dividend growers would tend to outperform the stock market over long periods of time. As a result, many income investors look to blue-chip dividend stocks with steady payouts when constructing their portfolios.

"Dividend growers generally have modest (35-50%) payout ratios and growing earnings. The modest payout allows for the company to either maintain or grow its dividend, even in difficult economic periods that result in down earnings," Halliburton says. "This cushion between dividend and earnings helps companies avoid capital destroying dividend cuts even when earnings are disappointing."

That said, this rationale has its flaws. Some, such as FlexShares' Huemmer, believe those flaws could be amplified in 2020 and beyond as companies struggle to deal with the pandemic.

"Consistently paying or growing a company's dividend is the result of past financial performance, not a sign of future dividend success. Focusing on dividend results ignores the current environment, changes in consumer tastes or global demand and how well-positioned a company is today," Huemmer says.

Extra Caution Required in Today's Market

While the above warning signs offer great guidance during more normal times, 2020 is -- without a doubt -- a historical outlier. Some stocks that wouldn't normally look like risky picks will end up cutting dividends. And, as evidenced by earlier examples, even blue-chip dividend stocks may suspend or cut their payouts.

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Donisanu says his firm is keeping an eye out for dividend pitfalls by "paying particular attention to cyclical firms whose top-line sales and earnings will be susceptible to the current economic downturn."

"Make sure that the stock of companies you're looking to buy for dividend income are producing goods and services that will still be in demand [during the pandemic]," says Halliburton, or that demand for those goods and services will see a quick rebound.