How to Invest in Stocks That Reduced Dividends
- 1). Exclude cyclical stocks. Cyclical stocks' earnings fluctuate with the economic cycle. Some of these stocks increase dividends in good times, and reduce or eliminate them in bad times. Since these cycles are known and predictable, a dividend increase or decrease is expected and does not have much bearing on the stock price.
- 2). Identify stocks with a history of dividend increases. Some companies pay regular dividends and even increase them periodically. Utility stocks are the best example. But every once in a while, a company with a history of dividend increases may experience financial difficulties and reduce or cut its dividend to conserve cash. These may be your buy candidates.
- 3). Review the company's news. Investors who buy stocks for dividend income obviously sell those that reduce dividends. Typically, a stock begins to decline before the dividend is actually cut as investors sell in anticipation. A company may initially deny dividend cut rumors, but eventually will be forced to act. A dividend reduction confirms the trouble and may be an indication of more bad news to come, so the stock may continue to decline. But at some point all the bad news is out, the dividend is cut or reduced and everyone who wanted to sell has done so. When things are as bad as they can get, the company may begin to turn around.
- 4). Look for market overreaction. When investors rush for the exit, the avalanche of sell orders may depress the stock price beyond any reasonable valuations. For example, a company may cut its dividend by 20 percent, but its stock will drop 50 percent, so that even with a reduced dividend the yield is still higher.
- 5). Buy stocks that have turned around. Use stock charts to confirm that a stock has hit bottom and is turning back up. It's important to use charts because the news and opinions about the stock may still be negative but some astute investors are already buying quietly. After a dividend has been cut, it can only be increased or resumed so you will be investing in future potential dividend income stream and price appreciation.
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