In this turbulent market, you might find yourself in search of a safe haven.
And what better spot to park your cash than dividend stocks?
The passive income they provide lets you sit back and collect your dues while the rest of the market rides this roller coaster.
I have some bad news, though…
If you think dividend stocks are your hiding spot…
You’re wrong.
Well, at least partially.
This year, a new tax law went into effect, and it might mean previously safe dividends will be on the chopping block.
It’s not all bad news, however.
Because instead of playing it safe, we can play it smart.
Let me explain…
Dividend Cuts on the Horizon
Although the 2017 Tax Cuts and Jobs Act was passed five years ago, some of its provisions didn’t trigger until this year.
One of these provisions affects the way companies treat research and development (R&D).
Long story short, while companies used to be able to subtract R&D from revenue – and essentially get a tax break for innovation – this expense is now treated more like an asset and comes out of free cash flow.
The bad news is that free cash flow is used to pay dividends.
And this change is already hitting the free cash flows of major companies. Just last week, Raytheon (NYSE: RTX) reported a 33% drop in its free cash flow.
When the margins grow slimmer between a business’s free cash flow and the dividends it pays out, that’s when you could be looking at a dividend cut.
Dividend cuts are up lately. There were 35 cuts reported in July 2022, which was 23 more than were reported in July 2021. This was the highest figure recorded since June 2020 (when many companies were cutting dividends because of the coronavirus).
But not to worry, it’s not all gloom and doom.
Work Smart… Even in Safe Spots
Dividend stocks are still a good investment – better than most, in fact.
But avoiding the cutters is crucial… When a company cuts its dividend, its share price tends to take a dive as well.
Many companies (especially in the tech sector) will be looking at decreases in their free cash flows – which will definitely put their dividends in the hot seat.
And they may draw you in with high dividend yields that, once you take a look under their hoods, you find simply aren’t sustainable.
This is where you have to outsmart the corporations. Getting ahead of dividend cuts will set you apart from average investors.
The way you get ahead of dividend cuts is by knowing how much a company is spending on its dividend. If it’s dedicating too much of its cash to these payments, then the dividend is likely to be cut.
For now, watch out for big R&D spenders. These investments need time to start bringing in money. And companies having to choose between expanding the business and paying a dividend are likely to choose expansion.
The dividend policy impact of the law will eventually fade as companies adapt to the change…
But if you want a steady (and increasing) payout from a company that is also growing its share price, it’s best to turn your attention to tried-and-true dividend stocks…
Look for balance sheets with increasing free cash flows. Those stocks are likely to be heading for dividend hikes.
Plus, if you’re able to anticipate a dividend increase, you can beat the market by getting in before the share price rises on the news – giving you higher returns and a nice dividend bonus for your trouble.
Good investing,
Brittan
P.S. If you’re looking for a place to get started, check out Marc Lichtenfeld’s FREE Ultimate Dividend Package right here.
