Are companies rushing their year-end dividend to avoid the fiscal cliff or is it just a last kiss goodbye to their payouts?

 

For the first time in 20 months, funds invested in Dividend ETFs are droppping

 

For the first time since many years, several companies are paying an special dividend before the end of the year

 

We are not Halloween, and yet we talk about Death… Dividend’s Death?

 

 

I’m taking a quick pause from my utilities dividend growth stock series to talk about the possible impact of the fiscal cliff. I don’t know if you have noticed this, but there are a lot of companies rushing their payout before the end of the year. In their announcement, they specifically mention that this exceptional ex-dividend date and dividend payout are prior to January 1st with the only goal of avoiding the possible new tax treatment on dividends in 2013.

 

Companies such as Oracle, Cisco, Seagate Technology, Wal-Mart, etc are paying their “regular” dividend in advance while other companies such as Wynn Resorts & Tyson Foods are paying a special dividend before the fiscal cliff. At the same time, companies who refuse to get in line and pay their dividend prior to 2013 like GAP will be penalized by the market and see their shares plummet. Do companies and Wall Street Golden boys know something small investors don’t? Are they planning on cutting their dividend after the fiscal cliff? Or is it the death of dividend growth?

 

Fiscal Cliff in Numbers

 

To answer these questions, we must understand what the fiscal cliff is. The Fiscal cliff is a combination of measures that will drastically increase the Government revenues and cut its expenses.

 

The revenue increases will come from the maturity of a series of special tax reductions that were enacted during the Bush Government.

 

The expenses cut will come from a series of arrangements decided by congress in 2011 in order to decrease the debt level.

 

The problem is that the combination of both measures creates a “hole” in the economy equivalent to 3.7% of the USA GDP. So unless we see incredible economic growth in 2013, we are heading directly into another recession. Being in a recession is one thing, but what concerns folks the most is the tax increase detailed as follow:

Fiscal Cliff Explained

The tax increase will mainly hit high income households along with capital gains and dividend payouts in general. I’m not a tax expert but I read that dividend income currently taxed at 15% could go as high as 38.6%. That’s more than 20% less in your pocket for every dollar received in dividends!

How the Fiscal Cliff Influences Dividend Growth Stocks

 

 

We all know that the main goal of any CEO of any public company is to keep the share value as high as possible and to generate profits. If the share value is up, it’s good for both investors and the CEO ;-). We also know that several stocks attract investors with their dividend growth policy. For example, what has been the point of holding JNJ for the past 5 years (stock value is +3.13% but dividends increased by 45% during the same period) besides its ever growing dividend payout? None.

JNJ GraphIn a historically low rate environment, solid blue chips have slowly replaced a part of bonds and certificates of deposit in the fixed income portion of a portfolio. It seems like a good way to buy a stock that will be relatively stable over time while paying a dividend that is taxed less. What do you think would happen if the reason why you hold a stock is impacted by a tax increase of 23%? You might sell the shares and look elsewhere for another investment opportunity.

 

Stocks May Hold Off On Their Dividend Growth Strategy

 

We recently talked about a potential dividend bubble due to the fact that investors were rushing into dividend paying stocks to compensate for low interest bonds. The word quickly spread and several companies started to increase their dividends and adopted a dividend growth policy in order to get on the train and attract more investors. I’m not making this up, check out this chart showing the huge dividend burst that happened upon the dividend tax cut to 15%:

 

Dividend tax rise fiscal cliff

So maybe the fiscal cliff is not the end of the world and dividend investing is not dead. However, strong dividend growth stocks might be hard to find if several companies hold off on their dividend growth policy. Instead of increasing their dividend increases year after year, they might keep their money and use it for other projects.

 

We Are Not Done Yet With The Fiscal Cliff

 

Back in April, I discussed the pros and cons of Obama rising taxes on dividend. I’m obviously not a fan of the situation but it might not be as catastrophic as we think. There are still a lot of companies that will continue to pay dividends. On the other hand, nothing has been settled yet and the Government could still continue to debate throughout the beginning of 2013 as the taxes will be applied during the year but most likely paid in 2014..

 

So there is still hope that the dividend tax won’t be hiked to 38% and that stocks will continue paying great dividends!

 

What’s Your Take? Are You Afraid of the Fiscal Cliff?

 

Dividend investors prefer to receive cash right now instead of playing on a potential company growth. But if the dividend payout is taxed too much, there might be a loss of interest towards dividend investing.

 

Do you think that dividend investing will be dead upon the fiscal cliff?

 

You Want More Tricks To Buy Dividend Growth Stocks?

 

If you are looking to:

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Avoid Tax Traps

 

Check out my book, there is a ton of insightful info on how to buy, manage and sell your dividend stocks!

 

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Disclaimer: I hold shares of JNJ & STX

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11 Comments   |  

11 Comments

michel
December 10, 2012, 8:27 am

My hope is that cooler heads will prevail! Or, that political parties will look beyond their own self interest and arrive at a compromise for the good of the people. I think the dividend strategy will stand the test of time, in spite of the decision they make (or do not take). Maybe a White Knight will come in…

Joey
December 10, 2012, 10:20 am

Even with 50% tax on dividends, JNJ still pays more than a 5-yr CD at my local bank. And that assumes I would tie my money up for five years at the bank, thus giving up any chance for dividend growth. I don’t see why I would do that.

December 10, 2012, 12:53 pm

Oh man. I didn’t think the dividend tax hike would affect us that much next year, but if companies start to slow down the dividend, that’s another story. I’ll keep any eye out and see what happens next year. Do you plan to diversify more into growth?

Mike
December 10, 2012, 1:49 pm

@Michel,
let’s hope that there are some brains among politicians :-)

@Joey,
you have a solid point; most dividend growth stocks are paying higher than any CD’s and it should remain that way for a while.

@Joe,
I’m not going to panic right away. Half of my portfolio is Canadian anyway so I won’t be affected as much as Americans. I’ll wait to see what will be the final call on the Fiscal Cliff prior to changing my investment strategy.

Joey
December 10, 2012, 3:20 pm

Thanks.
The part I am missing is why people think folks are not going to invest in dividend paying stocks just because the tax rate on divys increases. The tax increase on divys doesn’t affect funds held in non-taxable accounts. And it doesn’t seem to me that people would sell divy stocks to invest in CDs. About the only way I can see increased taxes on divys affecting the market is that some people will have less money to spend/invest because they did have to pay more taxes.

Can you help me understand this better?

December 10, 2012, 5:47 pm

I’m hoping most of the companies I own continue with their long history of dividend increases. I’m not sure what I’ll do if the likes of Coke, McDonald’s, Wal-Mart, PG, JNJ, etc, stop dividend growth or cut dividends. Fortunately, I don’t think this will happen but who knows!

December 10, 2012, 8:44 pm

I don’t see any disaster coming. This is just messy politics. Messy politics passes. Great companies prevail :)

Mark

December 10, 2012, 10:05 pm

I am not at all worried about the fiscal cliff. Companies that have the economics to boost dividends will keep doing so, no matter what the tax rates are. Companies which are focused on short term games, are not going to increase dividends. That would actually make it easier for income investors to focus on the real deal, and ignore the posers.

I actually hope that there is a drop in stock prices because of the cliff. A 20% drop would be awesome.

December 12, 2012, 2:36 am

Honestly, I am scared. If the tax hikes up to 40-ish something percent, the stocks may drop by 34% to make up the loss in yield, or slow down or whatever. That can become a serious damage to all savers and their portfolios. Well it’s too early to panic. All I can do right now is saving cash and be ready buying protective puts.

December 12, 2012, 8:25 am

I’m with DGI. Great companies will continue to reward shareholders through dividends. Think of the dividend streaks of some companies like KO, JNJ, PG and the like, they still increased dividends every year through the higher dividend tax rates so I don’t see any reason for them to stop now.

March 13, 2013, 6:08 am

[...] between the Republicans and the Democrats. They will have to argue on how to completely solve the fiscal cliff. If they can’t find a solution, major spending cuts doubled with tax increases will hit the [...]

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