Should you buy a stock on dividend cut?

9 years ago - Published in Finance, Fundamental Analysis

Given renewed investor interest in dividend cuts Morgan Stanley analysts have revisited their 2008 analysis that showed cuts to dividend can indicate powerful inflection points in share prices.
"We would buy stocks on dividend cuts, particularly those that are 'stressed'" is written in the European Equity Strategy of March 24th.

Investors increasingly focusing on dividend cuts.
Against a depressed earnings base, the market's dividend payout level looks high in an historical context.
Importantly, this trend is broad-based rather than driven by a few large sectors – e.g. the median stock's payout ratio is close to a 20Y high.
Consensus DPS forecasts continue to decline and DPS downgrades are comparable to 2011/12.

"We revisit the implications of dividend cuts: our conclusion is to buy stocks on dividend cuts.
We have examined over 350 instances of dividend cuts in Europe over the last 10 years. Our conclusions are largely in keeping with our 2008 report, and suggest the following:
1) A dividend cut typically represents a positive inflection point for share prices: The median stock outperforms the market by 11% in the year after announcement of a cut.
2) The best subsequent performance comes from stocks that:
– Had the highest yield prior to the dividend cut: the median stock that yielded more than 12% prior to the dividend cut announcement outperformed by 50% over the next year.
– Underperformed the most prior to dividend cuts: the median stock that underperformed more than 60% ahead of the cut outperformed by 56% over the next year.
– Cut their dividend the most: the median stock that cut its dividend by 60% or more outperformed by 18% over the next year.
Dividend sustainability could be at risk in some parts of the market.
Dividend cover for commodities and some defensive sectors looks low, both from an absolute and historical perspective, and these sectors pay out a large part of the market's dividend. This suggests market sustainability of dividends could be at risk, with 91% of MSCI Europe's dividend from industry groups with trailing dividend cover in the bottom third of the 10-year range.
We run 3 screens for stocks whose dividends might be at risk.
i) Stocks that have high leverage and high dividend yields; ii) Stocks with a high dividend yield and a negative free cash flow yield; iii) Stocks whose current payout ratios are the highest in their 10-year history. The screens are a good starting point to examine stocks displaying higher risks of dividend cuts"