The bankruptcy of grocer Winn-Dixie (OTC BB: WNDXQ) rang a very loud bell for me.
Before Mathew Emmert lent his pen to the Motley Fool Income Investor newsletter, before the Internet brought 31 flavors of stock screens to your desktop, there was Moody's Handbook of Dividend Achievers. I first ran across this gem -- essentially a list, with profiles, of every stock that had paid an increasing dividend for the prior 10 years -- in Peter Lynch's Beating the Street.
After digging the 1995 edition of the Handbook out of the basement (I have a hard time parting with things), I realized what had that gong ringing in my brain. There, perched atop the list, having increased its dividend every year for the last (at the time) 51 years, was Winn-Dixie.
What happened in a decade for the company to go from increasing dividends annually since FDR's administration to Chapter 11? And how could the astute Fool have managed to avoid taking the Winn-Dixie highway to its painful dead end? Better yet, what can we learn to avoid similar disasters?
What happened was fellow dividend achiever Wal-Mart's
One of the trickiest questions to answer is: When do I sell? One answer is: When your reasons for buying the stock are no longer valid. In the case of a dividend play, when the dividends dry up. Let's look at Winn-Dixie's dividend history adjusted for splits (I'll skip the first half-century):
There are a couple of warning signs here, and we'll look at each of them in order:Trip Wire No. 1: Declining dividend growth
For a dividend achiever, you should be looking for an increase in the year-over-year dividend growth rate and be willing to consider a sale when it does not materialize. In reference to the chart above, you'd want to sell after FY97, since the growth rate of 8.5% falls short of the prior year's 13.5%. Sure, you'd have missed a 25% run-up in FY98, but you'd have missed a world of hurt that followed. I make three exceptions to this rule:
Historical payout ratios have been less than 20%. I'm buying these stocks for something other than dividends, and I'm not really concerned with the dividend policy.
The company has increased the dividend by the same dollar amount. By definition, this will produce a decline in dividend growth. I have no illusion that corporate boards worry themselves about a continuous growth model when they set dividends -- adding the same amount every year is common and fine with me.
The current increase is larger than the last-five-year average. Occasionally a one-time bump in payout will make a single year a hard act to follow; therefore, I look at the five-year compounded annual growth rate (CAGR). That's not the case here -- the 1997 growth rate of 8.5% lags the '91-'96 CAGR of 10.4%.
Trip Wire No. 2: Same dividend as last year
Few of us have 0% growth plugged into our valuation models, even for dividend-paying stocks, especially when those dividends will be worth 2%-3% less each year from inflation alone. Tack on the fact that 1999 broke a string of 55 consecutive years of increasing dividends, and we're looking at a red flag big enough to annoy the most docile bull.
Trip Wire No. 3: Reduced dividends
Companies will do just about anything to avoid cutting dividends. By 2001, the company had sent a huge signal that all was not well in the heart of Winn-Dixie despite paying out over twice what it had earned. The following years proved the signal correct.
That's all very well for the past, you say, but what about now? Take a look at Altria
Yes, Altria was up 12.3% in 2004 on top of the dividends. Winn-Dixie was up 25.4% the year after its dividend growth started to decline. Also, you need to factor in stock repurchase activity (tapering off in 2004 for Altria) as a means of using cash to build value for the investor, but remember, the dividend figures are already per-share. These sell signals are tools like any other and are not absolute -- but if you are investing for dividends, you can't afford to ignore these warning signs.