Dividend stock investors enjoy getting cash back from their investments on a regular basis. Yet the worst news that a dividend investor can receive is that a company has chosen to reduce or eliminate its payout. That's because the news often comes with a double hit: Not only do you lose your dividend payment, but the stock price often reacts negatively, as well.
That's what happened with longtime dividend stock Walgreens Boots Alliance (WBA -0.62%) in early January. The drugstore chain came into 2023 with a streak of 47 straight years of increased dividends, and technically, it made that streak 48 years by paying more in total dividends last year than it had in 2022. However, that streak came to an abrupt halt when Walgreens slashed its dividend by 48% to $0.25 per share, falling just short of the 50-year mark that would've qualified the company as a Dividend King.
Walgreens showed some of the warning signs that would've alerted shareholders to a potential problem. Here are four key things that every dividend stock investor should keep an eye out for.
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1. Slowing dividend growth
The best dividend stocks have healthy growth rates in their dividend payouts. When previously large annual hikes give way to more modest or even token boosts, it's a sign to look more carefully at what's happening with the company.
Walgreens is a good example. It routinely gave double-digit percentage dividend increases throughout the late 2000s and early 2010s, including a 10% rise as recently as 2018. However, beginning in 2020, Walgreens boosted its quarterly payout by just $0.01, representing a roughly 2% increase. 2022's hike was just $0.0025 per share.
Dividend stocks like to keep their streaks alive, and that quarter-penny increase was enough to get the job done. But it doesn't convey as much underlying business strength as a larger boost and can sometimes set the stage for more dramatic action later on.
2. Sharply rising dividend yields
Dividend yields reflect two things: the payout and the stock price. The share price is a good indicator of the health of the overall business. When stock prices fall, dividend yields rise.
Some dividend investors see that as a positive sign, giving them more bang for their investing buck. However, unless shareholders are irrationally bidding the stock price down, there's usually a reason for concern.
In Walgreens' case, the drugstore chain had to deal with sluggish corporate performance at the same time it pursued a dramatic transformation of its business to include primary-care clinics. That sent the share price sharply lower, boosting the dividend yield.
Combine those challenges with higher costs of capital due to rising interest rates, and new CEO Tim Wentworth had little choice but to reduce the dividend payout to preserve cash for capital expenditures. The reduction will send Walgreens' yield back down to more normal levels for the drugstore stock.
WBA Dividend Yield data by YCharts.
3. Losses or deteriorating earnings
In some ways, paying a dividend is simply a reflection of how much a company is earning. Indeed, some dividend stocks expressly tie their payout amounts to earnings or other financial measures. It's generally a warning sign when earnings fall below the amount of the dividend, with sustained losses being particularly troubling.
For years, Walgreens paid far less than it earned, raising a few concerns about the sustainability of its dividend. Yet the big jump in payout ratios beginning in 2020, followed by outright losses over the past year, represented a steady progression that put the dividend in jeopardy.
4. Failed restructuring efforts
Often, companies overextend in their growth strategies. That can force them to consider ways to retrench. Sometimes, they have to raise cash or pay down debt; other times, they can simply refocus on their core businesses. If those retrenchment efforts don't pan out, it can require more dramatic moves.
Two years ago, Walgreens started conducting a strategic review of its Boots pharmacy division, and it appeared as though the company would sell off the U.K.-based Boots in the summer of 2022. However, that deal fell through amid concerns that the selling price was too low.
Just last month, though, Walgreens once again started looking at ways to use Boots to raise capital, perhaps through an initial public offering of the British pharmacy chain. In the end, such explorations weren't fast enough for Wentworth to save the dividend.
Hope for the best but plan for the worst
When a company has paid rising dividends for decades, it's easy to understand why investors get complacent. However, even the most durable businesses can run into obstacles they can't overcome. Dividend investors have to be on the lookout for the things that can give them advance notice of a potential problem before it hits.
