Cut in dividend payouts will reduce your income and also your portfolio value. To avoid this, do not invest more than 15% of your portfolio in a single sector.
Every economic downturn is different in its own way. But, the current Covid-19 poses an unprecedented threat to the global economy. Countries across the world adopted different tactics ranging from different versions of lockdowns, work from home, strict quarantine, severe restrictions on international and domestic travel, etc., which have brought business virtually to a halt. Now, many dividend paying sectors are cutting their payouts. So, if you are an investor, here is how to handle the reduction in dividend income.
Why dividend cut?
A quick empirical check on the BSE listed companies, during the last one decade, reveals that dividend payout ratio has increased from 30% to roughly 50% whereas for banks this increase is around 22%. But it has not been a happy start to the year for dividend stocks. Leading oil companies have cut their dividend and have also suspended their share buyback programme. The Reserve Bank of India (RBI) recently barred banks temporarily, from paying dividend for FY 2020 as a policy measure and asked them to conserve capital. Banks are under much strain due to lockdown and the three-month moratorium on loan repayments. This undistributed profit of the companies can be used as a reserve to cushion the fall in demand expected in the forthcoming months or can be used as a buffer against a crisis or for expansion.
What should investors do?
As many of the traditional dividend paying sectors are stopping dividends, what should investors do for a reasonable and sustainable yield. If the dividend cut surprises the market, the share price will drop immediately. Therefore, one cannot really get out of it fast; rather, one must first accept the loss of both revenue and capital. Then, one must find out the reasons for dividend cut and wait for a couple of days before taking any decision. Thus, the rational way to come out of such problem is to wait until share price comes back.
Is it good to buy more on the dip?
Often, investors attempt to buy more shares on the dip and do some cost average. The logic is that you already hold some shares at Rs 10, why not buy more at Rs 6 and get your average price down to Rs 8. So, once when the share bounces back, you will be able to sell them faster. But investors should note that this strategy can make sense only if the company has some plan to revive the business.
Diversification is the key
A dividend cut announcement is definitely not good news for investors. It reduces your immediate source of income and it cuts a good part of your portfolio value. To avoid such things, do not invest more than 15% of your portfolio in a single sector. Diversification is the key.
Companies in sectors such as consumer staples, pharmaceuticals, utilities are resilient and may actually benefit from lockdown. Dividends will not disappear completely as some sectors may just suspend payments until things revive while others will reduce rather than cancel.
To conclude, the synchronised global shutdown presents an unprecedented challenge to dividends payments. So, investors should adopt the above strategies to beat the dividend cut blues.
The writer is a professor of finance & accounting, IIM Tiruchirappalli