Can A Statistical Test Predict Dividend Cuts?

Published in Investing on 12 July 2012

Are dividends in danger at these 12 companies? Another look at spotting the danger signs.

When is a high yield too high? For income investors, it's a critical question.

A beaten-down share, in short, often offers a juicy yield -- but the company in question could well be beaten-down for very good reasons. And that tasty-looking yield promptly vanishes as the dividend is slashed.

As I wrote the other day, poor dividend cover is one sign of a dividend that may be cut. Other financial metrics, such as poor interest cover, trigger similar alarms.

But here's another way of spotting potentially problematic payouts.

Blast from the past

A couple of years ago, I related how, back in June 2007, I'd set about looking for suspiciously high yields, using a dividend spreadsheet periodically published by longtime Fool reader StepOne -- a much-valued tradition now carried on by Kiloran.

Simply put, for those of you with a statistical bent, I was looking for yields that were more than one standard deviation greater than the FTSE 100 (UKX) average yield.

For those of you not of a statistical bent, 'standard deviation' refers to the measure of dispersion in a population or sample. In other words, I was looking for shares with a yield sufficiently far away from the average so as to be suspicious.

At this point, I won't say any more: refer back to the original article for further details. Suffice to say that the vast majority of the 14 shares identified went on to hit trouble -- cutting the dividend, launching rights issues, going bust, or indeed some combination of all of these. Check the list to see for yourself.

Danger list

Two years on, I thought I'd repeat the exercise -- but looking for shares displaying danger signs today.

Put another way, which shares -- right now -- have yields high enough to trigger alarms?

Twelve companies, it turned out, have forecast yields that are one standard deviation or higher than the FTSE 100's average forecast yield of 3.7%:

CompanyForecast yield
Resolution (LSE: RSL)10.1%
Aviva (LSE: AV)8.9%
RSA Insurance (LSE: RSA)8.7%
Vodafone (LSE: VOD)7.5%
Admiral (LSE: ADM)7.1%
BAE Systems (LSE: BA)6.6%
AstraZeneca (LSE: AZN)6.3%
Standard Life (LSE: SL)6.2%
SSE (LSE: SSE)6.0%
National Grid (LSE: NG)6.0%
Legal & General (LSE: LGEN)5.7%

Source: Bloomberg

Cause for concern

Interestingly, I hold four of these shares myself. At least seven are popular picks with most income investors, such as those who you'll find on our popular High Yield Portfolio discussion board.

So should we be worried?

The answer, in short, is both 'yes' and 'no'. A steady-as-you-go utility such as SSE, for instance, can afford a high payout. What's more, SSE prides itself on its payout, boasting that it is one of just six FTSE 100 companies to have delivered a real dividend increase every year since 1999.

Other companies, such as BAE Systems and AstraZeneca, seem to have high yields because worries about their prospects have -- hopefully temporarily -- driven down the share price.

But other companies would seem to have a case to answer. The new chairman at Aviva, for instance, will only go so far as to express the hope that the dividend can be maintained. And as I wrote last week, Standard Life and Admiral join Aviva in suffering from low dividend cover as well.

Woodford holds two

One investor well used to evaluating the prospects of income shares, of course, is Neil Woodford, who looks after two of the country's largest investment funds and runs more money for private investors than any other City manager.

And interestingly, two of these shares feature among his very largest holdings -- a strong sign that he sees their dividends as being sustainable.

Which two companies are they? All is revealed in this free special report from The Motley Fool -- "8 Shares Held By Britain's Super Investor" -- profiles eight of his largest holdings, and explains the investing logic behind them. Including the two shares in question, of course.

Is he worth listening to? Well, on a dividend re-invested basis over the 15 years to 31 December 2011, Mr Woodford has delivered a spanking 347% return, versus the FTSE All-Share's distinctly more modest 42% performance. Which, to my mind, speaks for itself.

So why not download the report? It's free, so what have you got to lose?

Want to learn more about shares, but not sure where to start? Download our latest guide -- "What Every New Investor Needs To Know" -- it's free. The Motley Fool is helping Britain invest. Better.

More investing ideas from Malcolm Wheatley:

> Malcolm holds shares in Aviva, AstraZeneca, BAE Systems and SSE. He does not have an interest in any other share mentioned.

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The opinions expressed here are those of the individual writers and are not representative of The Motley Fool. If you spot any comments that are unsuitable hit the flag to alert our moderators.

alarmbells 12 Jul 2012 , 5:42pm


... why spoil a decent article by referring to flippin' Woodford again?

Tell you what, just for a change take a look at another successful long term investor (but not Warren 'the-fool-must pay-me-a-commission Buffet.)

Other than the silly plug for a weak report whose contents (Woody's top shareholdings) can be found by anyone with the ability to click trustnet - a decent article.

Instead of quoting woody and the silly Fool link the article would have been stronger by quoting research that indicates best performers are high yielders but not the highest yielders. Google Dreman's work.

More research and less quoting easy sources, please.

Brockasaurus 13 Jul 2012 , 8:10am

Dividend yields are far from normally distributed so I don't think it makes sense to measure them in standard deviations from the mean.

What you are essentially doing here is looking at yields that exceed a certain level and suggesting they are high for a reason. But that is always true! Investment is inherently about taking risk. If the future were clear, rosy and bright, these firms would not be yielding 6%+...

If you want to forecast dividend cuts, I think you could build a decent model using several inputs, like:
- current yield minus trailing average yield (to spot 're-rated' stocks)
- dividend cover (to spot those who are feeling the pinch)
- share price volatility, or some measure of 'falling knife-iness' like a count of daily returns exceeding 10% in the last year (for example) (to spot the stocks the market is unsure about)

You might discover that some magic combination of these variables (and others) predicts dividend cuts fairly successfully (in and out of sample, perhaps!). But I don't have the data so I have not bothered.....I just diversify and wait.

(Sorry if there are terms in this reply that require a bit of googling)

Excel35 13 Jul 2012 , 8:52am

@alarmbells, yes I too have had enough of the constant references to Buffet and Woodford in virtually every article. I've never before noticed such a poor way of advertising something, literally ruining every article they publish.

Come on have a bit of respect for the readers. There are plenty of other ways to advertise.

steve695 13 Jul 2012 , 12:29pm

Aside from David Dreman's work, I believe that James O'Shaughnessey's What Works On Wall Street also indicated that those shares in the second and third deciles when ranked by yield outperformed those in the top decile over long periods. I'll need to double check my copy of the book just in case my rusty memory has this wrong.

Completely agree about the references to Woodford again. This was interesting the first time, it isn't the 57th. Otherwise, good article, keep it up.

sendaiben 13 Jul 2012 , 1:40pm

Yes, please: enough of 'the one share Warren Buffet is buying', and 'the eight shares Woodford holds' already...

I think I have downloaded both of those multiple times ;)

ribuck 13 Jul 2012 , 2:56pm

Besides, Warren Buffet isn't actually buying that share right now. He has bought it in the recent past, which isn't quite the same thing.

Like the others say, please don't insult our intelligence by these advertorial inserts.

squashcoach 13 Jul 2012 , 3:36pm

What's the problem with mentioning Woodford? Surely he's mentioned because he is successful and, if the subject is about investing for income, he is as good as anyone and better than most.

I've been with Woodford since the early 90's and I'm not ashamed to admit I'm a fan.

koochak 13 Jul 2012 , 4:06pm

I'll show you an easier way:
Take the long-term gilt yield. Multiply by 1.5. Any share yield greater than this is suspicious.

moreuseless 14 Jul 2012 , 9:06pm

Very disappointed. No mention of Warren Buffet (or the report you can download). I was hoping for at least 4 mentions!

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