Under ordinary circumstances, business enterprises facing a possible economic meltdown typically won’t reward shareholders, whether through stock buybacks or dividends. Instead, the priority is to survive the incoming onslaught so that such rewards may be distributed at all. Yet The Wall Street Journal noted recently that publicly-traded companies spent record amounts on dividends despite numerous troubles. It begs the question, can this narrative last throughout the new year as the market and economy trend lower?
At first, the sheer dollar amount appears almost fantastical relative to underlying worries. According to S&P Dow Jones Indices – a unit of S&P Global (NYSE:SPGI) – enterprises listed in the S&P 500 (SPX) “allocated an estimated $561 billion toward dividends in 2022, up from $511.2 billion in 2021 and the highest amount on record.”
Further, the WSJ added that “dividend spending is poised for another record in 2023 as companies are under pressure from investors to keep increasing returns, said Howard Silverblatt, a senior index analyst at S&P Dow Jones Indices.”
At the same time, market observers carry reasonable concerns about the sustainability of such dividends this year. With the Federal Reserve raising the benchmark interest rate, borrowing costs naturally increased. Effectively, though, this framework disincentivized growth-oriented companies from maintaining their expansionary ambitions. Not surprisingly, then, one of the byproducts has been mass layoffs.
Again, embattled enterprises’ first priority should be survival. Otherwise, it doesn’t make much sense to extract dividends from defunct entities. Yet, many companies insist that paying out passive income represents a viable and sensible approach.
Why Dividends May Continue in 2023
Heading into the new year, more than a few respected market experts warned about a possible downturn, ranging from a U.S. recession to the worst-case scenario of stagflation. Interestingly, though, unlike the Great Recession, an upcoming downturn wouldn’t come as a surprise. Indeed, this time around, businesses are prepared for potential turmoil. Therefore, their confidence in still paying out dividends carries greater credibility.
For instance, the aforementioned WSJ report recognized that businesses have become less optimistic about the U.S. economic outlook.
Still, as journalist Mark Maurer pointed out, “cutting or canceling dividends is generally a last resort as doing so signals worry to investors. Many companies say they are confident they have sufficient cash flow to fund payroll, capital investments and other expenses that they can capably reward shareholders through dividend payouts for at least the near future.”
The last sentence above deserves careful consideration, as in reading the fine print. As stated earlier, if a downturn materializes, it’s not going to catch enterprises – particularly the blue chips – off guard. One does not need to go far to find bearish prognostications. By logical deduction, enterprises that pay dividends likely factored in key headwinds.
If they believe they can still provide passive income to stakeholders, the words may be more than mere bravado.
Investors Must Still Exercise Caution
In August last year, The New York Times ran an op-ed by Jeff Sommer in which the finance author listed brewing criticisms of stock buybacks. For instance, Sen. Chuck Schumer bluntly stated that he hated the practice. “I think they are one of the most self-serving things that corporate America does.” Yet, buybacks and dividends point to the same objective: rewarding shareholders, and that’s where a key fundamental problem lies.
Typically, investors can benefit financially from stocks through two mechanisms: capital gains or passive income (dividends). Under normal circumstances in the stock market, individuals and institutions pool their money together to fund enterprises that can potentially yield a positive return. However, in the new normal, these enterprises are not guaranteed to stick around.
Again, with the Fed tightening the money supply through higher rates, consumer spending declined across the board. Therefore, an argument exists that companies should focus on navigating potential turmoil in 2023 rather than rewarding shareholders. The time to reward investors will always be available so long as the underlying enterprise exists. However, once the stock falls to zero, that’s it – game over.
In simple terms, paying dividends during difficult times runs counter to the Israeli martial art Krav Maga’s core fighting principle: address the immediate danger first before addressing secondary threats.
Certain Dividend Stocks May Win Out
Given the delicate balance between fiscal generosity versus survivability, it’s probably not possible to provide a clear-cut answer as to whether record dividends can survive in the new year. However, dividend stocks from specific industries – such as utilities and insurance – will likely win out. That’s because these sectors benefit from inelastic demand or demand that’s consistent and predictable irrespective of pricing fluctuations.
With so many vagaries ahead of investors in 2023, many will almost certainly pay a premium for such reliability.