Never Look a Gift Dividend in the Mouth

Sometimes a cash rich company will declare a special one-time dividend to eliminate surplus cash. These special dividends are generally ignored when evaluating a company’s dividend growth performance. An example, of this would be Microsoft’s (MSFT) special $3.00/share dividend in 2005. Most analysts in-the-know exclude the $3.00/share special dividend use the $0.32/share regular dividend when calculating a dividend growth rate for Microsoft.

The situation is more complicated when a company distributes the excess cash via its regular dividend. Often, this leads to a situation where a company appears to have a dramatic increase in its dividend, then followed by decrease in the following year. Consider the following two companies I came across while running my D4L-PreScreen.xls model:

AT&T (T)

In 2002 T paid a dividend of $1.07/share, $1.37/share in 2003 and $1.25/share in 2004. Excluding the bump in 2003 there is a very smooth up-trend.

Avon Products Inc (AVP)

This one is a little more tricky when you look at the raw data. In 2003 AVP paid a dividend of $0.42/share, $0.70/share in 2004, $0.66/share in 2005 and $0.70/share in 2006. AVP saw a dramatic increase in 2004, with a slight pull back in 2005 and 2006 was flat with 2004.

Historically, when the companies lowered their dividends my approach would have been to sell the stocks if I owned them and exclude them from purchase consideration if I didn’t own them. As an investor with a long-term perspective, does this approach produce the desired results?

In both cases above, it would have been the wrong decision to sell the stock as a result of the companies lowering their dividend. A dividend investor should never look a gift dividend in the mouth and punish a company for its generosity. I will gladly take the extra cash when offered.

I have modified my analytical model to take the above situation into account. Specifically, I have introduced a new concept of “uptrend years.” An uptrend year ignores a decrease if the current year dividend is greater than 2-years prior, thus preserving the uptrend. A Star is now awarded for 10 or more uptrend years; one is deducted for less than 5. It is important to note that investing should never be purely a mechanical approach. An investor should always judge the unique facts and circumstances before making a trade.

Disclosure: No position in any of the aforementioned stocks.

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