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Two signs that could signal a company's about to cut its dividend

by , 04 November 2014

If you're an income investor, the last thing you want is to invest in a company for its dividend and for the company to cut it.

Even if you're not investing solely for a company's dividend it can be worthwhile finding out more. When a company regularly pays a dividend then cuts it or withholds it, chances are the share price will fall as a result.

So what can you look at when it comes to checking the safety of a company's dividend?

Let's take a closer look…

Dividends are in danger when a company has too much debt

When a company accumulates too much debt, one of the things at the top of its list to cut back on will be dividends.

If a company has a lot of debt, it has to pay interest payments on it. These interest payments aren’t optional. Dividend payments are.

The more debt a company carries, the more interest the company needs to pay. And this means less money for shareholders.

The situation can worsen if trading conditions deteriorate. The company will be under more financial pressure to fulfil its interest payments.

So when checking out a company’s debt, make sure you look at forms of hidden debt, Phil Oakley in Money Week explains. This includes rental commitments for buildings and equipment.

Debt like this ranks higher than paying a dividend in a company’s cash flow and it will take priority.

Dividends could be under threat when a company scrimps on investment

One way that companies can boost their profits and cash flow is by not replacing assets when they wear out. The result is old assets.

So how can you find this out?

You’ll be able to find out the rough age of a company’s assets by looking in the notes of its accounts. Then divide the accumulated depreciation of its assets by the annual depreciation charge.

If assets are getting long in the tooth, and especially in comparison with its peers, you need to delve a bit deeper.

So there you have it. Two signs that could signal a company’s about to cut its dividend.

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Two signs that could signal a company's about to cut its dividend
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