Of course a dividend cut is the worst thing an investor in dividend growth stocks can have happen. You just lost some of your future dividend income that you were expecting to be there. This is why it's best to have a margin of safety in your dividends received versus your expenses when you're planning to live off just the dividends. Assuming that you didn't see the dividend cut coming and didn't sell out of the position before hand, just how bad is it?
Well let's run through the calculations. We'll assume that you have a portfolio that provides $20,000 in annual dividends. This portfolio is invested in several companies and for the sake of making the calculations easier we'll assume that all the positions carry a 3.00% yield and are equally weighted in the portfolio. I'll run through the calculations with various position amounts. So how bad is that dividend cut?
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If your portfolio consists of 10 different equal weight positions and one company announces a full dividend cut, then you just lost $2,000 in annual income. That means you now have 10% less to spend on your expenses. Well, is this really as bad as it sounds? In order to still have $20,000 in dividend income the other 9 positions would have to average an 11.11% increase in their dividend to get you back up to $20,000. That seems a little high but it's not anything that's completely impossible.
If your portfolio consists of 15 positions, your lost income is only $1,333.33 meaning you lost 6.66% of your dividends. That means the other 14 positions would need an average dividend growth rate of 7.14% to get you back to $20,000 in dividends. This is getting better and better. A 7% dividend growth rate is easily attainable from the likes of KO, JNJ, PG, CVX and the like.
Running through the calculations for a 20 and 25 position portfolio means that the remaining positions would need to increase their dividend by 5.26% and 4.17% respectively. This is very comforting knowing that should a dividend cut happen a 20 to 25 position portfolio can easily overcome the loss of dividends within 1 year. I try to invest in companies that I feel have extremely large moats that I shouldn't have to worry about the possibility of a dividend cut. However, I do own some smaller companies that a dividend cut could potentially happen at some point in the future if growth happens to stall.
And even better news, is this assumes that you not only didn't see the potential dividend cut coming but also lost all of the capital. In reality most companies, save the Enron's/Worldcom's, don't go bankrupt overnight with no foreshadowing of any underlying issues to the company. So even if a company does announce a dividend cut, 99.99% of the time you can still sell out of your position if you're worried about the sustainability of the company and recoup some of your capital to help make up for the lost income. This would further reduce the required growth rate from the rest of your portfolio to pick up the slack.
I'm not saying that I would welcome a dividend cut, but sometimes running through the numbers will help shed light on just how much damage or little damage it might cause.