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Equities

How will dividend stocks respond to COVID-19?

David S. Park
Portfolio Manager and Director of Research, Co-Head of Santa Barbara Asset Management
David A. Chalupnik
Head of U.S. Active Equities Portfolio Management, Co-Head of Santa Barbara Asset Management
Water droplet reflecting fallen leaves

The volatility fueled by the coronavirus outbreak is reminiscent of prior periods of market stress in which investors worried that dividend-paying companies would decrease or suspend their payments. Although 2020 could prove to be the most challenging year for dividend payers since the financial crisis, the sector make-up and impact of dividend cuts should be different. Additionally, many companies appear financially healthy and therefore able to maintain, increase or initiate dividends, despite the uncertainty. Our outlook for dividend sustainability is thus cautiously optimistic.

Should investors expect companies to cut their dividends?

Historically, the sectors most likely to cut or suspend dividend payments in times of crisis has depended largely on the specific drivers of the economic stress. Our analysis of dividend actions by companies during two severe market downturns, the 2008-09 financial crisis and the 2015-16 global oil price collapse, demonstrates this.

2008-09: Pop goes the housing bubble

The financial crisis was precipitated by a housing bubble abetted by lax lending standards, resulting in mortgages and mortgage-backed securities of poor credit quality. When the bubble burst, banks were hit by massive asset writedowns, which tightened financial conditions globally and led to the Great Recession. In 2008, 41 companies decreased their dividend, and 21 announced suspensions. In 2009, 68 companies cut, while 10 suspended.

Not surprisingly for a credit-driven crisis, the financials sector had the largest number of dividend cuts in the two-year period, as shown in Figure 1. The consumer discretionary sector experienced its share of cuts and suspensions amid soaring unemployment, lost personal income and a steep decline in consumer spending. A number of other sectors, including health care, utilities and consumer staples, were more resilient, resulting in far fewer dividend cuts.

Figure 1: Bar chart
2015-16: Oil’s slippery slope

From 10 June 2015 to 11 February 2016, crude oil prices plummeted by more than 57%, from $61.36 to $26.19 per barrel.1 This sharp and sustained drop in the price of oil exposed the vulnerability of companies, particularly in the energy sector that were generating cash flows insufficient to fund their capital spending and production growth targets. As oil prices declined, companies struggled to pay existing debt obligations, let alone sustain their dividend payments. As a result, the energy sector saw the greatest number of dividend cuts and suspensions during this period compared to other market sectors, as shown in Figure 2.

Figure 2: Bar chart
Good news was hiding in plain sight

While financial headlines during these two crises may have accentuated the negative, it’s worth noting an obvious but perhaps underappreciated fact: Most dividend-paying companies grew their dividends in both 2008-09 and 2015-16.2 In fact, for the four years combined, dividend increases accounted for the overwhelming majority, 86%, of all dividend actions taken.3

While there are no guarantees, it’s clear that dividend sustainability is possible even in the face of extreme shocks to the system.

What might investors expect from dividend-paying companies?

Unlike the previous two crises, the current turmoil is being fueled not by credit or market factors, but by a global health emergency in the form of the COVID-19 pandemic. The policy responses and countermeasures to the outbreak, in turn, are driving the world toward a potentially deep recession. Against this backdrop, many companies have begun drawing down lines of credit or taking advantage of low rates by issuing debt while they can. Share buybacks have been put on hold or significantly scaled back to preserve cash, especially among companies that are seeking government assistance. Further, some companies have already moved to lower or suspended dividends as they seek to shore up their balance sheets, build cash positions, improve flexibility and align payouts with their uncertain earnings outlooks.

While we think the remaining months of 2020 will likely see the most dividend cuts and suspensions since the financial crisis, the sectors most affected, and the specific impacts of these cuts, should be different.

Five sectors to watch

While the current demand shock and subsequent policy responses have implications for every economic sector, we believe companies in the following areas may be disproportionately affected — and thus more likely to decrease or suspend their dividends:

1. Financials. We anticipate fewer dividend cuts in the financials sector compared to 2008-09. One issue that bears close scrutiny is the impact of falling interest rates on net interest income.

2. Consumer discretionary. Given social distancing, shelter-in-place edicts and other countermeasures put in place to stop the spread of the virus, this sector is likely to be one of the most severely impacted — particularly companies related to travel, leisure, restaurants or retail.

3. Energy. This sector is being buffeted by both lower demand and higher supply. On the demand side, travel restrictions and other countermeasures to stop the spread of the coronavirus have contributed to oil’s 66% decline from the beginning of 2020.5 As for supply, efforts to reduce output in the face of a global oil glut were complicated by a price war between Saudi Arabia and Russia.

4. Industrials. Extraordinary pressure on the energy sector, coupled with travel bans, could lead to dividend cuts among industrials, too.

5. Materials. This is a highly cyclical sector. As such, it’s likely to see some dividend cuts, as it did in 2008-09. Among industries, basic chemicals appears to be at the greatest risk of needing to reduce dividends. With dividend yields around 10%, a flattening production curve for global ethylene/propylene and oil prices in the doldrums, this group could find it very difficult to compete going forward.

We consider the six remaining sectors — communication services, consumer staples, health care, information technology, real estate and utilities — to be in better shape than the other five. As a result, we don’t believe they will experience a significant number of dividend cuts or suspensions.

Navigating the crisis with a focus on fundamentals

We are cautiously optimistic about the prospects for dividend sustainability in the current market, while recognizing that experiences will differ among sectors. In conducting fundamental research on dividend-paying companies, we will continue to monitor the rapidly changing environment and the challenges it poses for companies we consider for investment. Ultimately, our perspective is broader and longer-term than a focus on potential dividend actions in the context of the coronavirus crisis. As always, we favor high-quality, dividend-paying companies with healthy balance sheets, free cash flow acceleration, capital flexibility and sustainable payout ratios.

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Endnotes

1 Based on the West Texas Intermediate (WTI) – Cushing, Oklahoma crude oil price (daily observations). Source: U.S. Energy Information Administration via FRED

2 Increases include first-time dividend payments from companies that previously did not pay a dividend

3 Standard & Poor’s

4 Standard & Poor’s

5 The WTI – Cushing, OK crude oil price began the year at $61.15 per barrel and stood at $20.51 per barrel on 31 March 2020. Source: U.S. Energy Information Administration via FRED

6 FactSet

7 FactSet

Glossary

OEMs (Original equipment manufacturers) are auto parts makers that supply components to auto manufacturers, who use the parts to assemble vehicles sold under their own brand name. E&P (Exploration and production) – E&P, or “upstream” energy companies, are principally engaged in finding oil and/or natural gas deposits, extracting these resources through well drilling or other methods and selling their output to “midstream” companies, such as processing and storage facilities and pipeline operators. MLPs (Master limited partnerships) are investment structures that pays no income taxes at the corporate level if it generates 90% of its income from qualified sources as defined by the Internal Revenue Service and distributes at least 90% of its earnings to its investor partners. The MLP ownership structure is most commonly seen in the midstream energy sector. Midstream C-corps are midstream energy operators organized as “C-corps,” the traditional corporate structure of publicly traded companies.

A word on risk

This material is provided for informational or educational purposes only and does not constitute a solicitation of any securities in any jurisdiction in which such solicitation is unlawful or to any person to whom it is unlawful. Moreover, it neither constitutes an offer to enter into an investment agreement with the recipient of this document nor an invitation to respond to it by making an offer to enter into an investment agreement.

This material may contain “forward-looking” information that is not purely historical in nature. Such information may include projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. Moreover, certain historical performance information of other investment vehicles or composite accounts managed by Nuveen may be included in this material and such performance information is presented by way of example only. No representation is made that the performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example.

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Nuveen to be reliable, and not necessarily all-inclusive and are not guaranteed as to accuracy. There is no guarantee that any forecasts made will come to pass. Company name is only for explanatory purposes and does not constitute as investment advice and is subject to change. Any investments named within this material may not necessarily be held in any funds/accounts managed by Nuveen. Reliance upon information in this material is at the sole discretion of the reader. Views of the author may not necessarily reflect the view s of Nuveen as a whole or any part thereof.

Past performance is not a guide to future performance. Investment involves risk, including loss of principal. The value of investments and the income from them can fall as well as rise and is not guaranteed. Changes in the rates of exchange between currencies may cause the value of investments to fluctuate.

There are specific risks associated with international investments, such as foreign company risk, market risk, currency risk and correlation risk. In addition, investing in securities of developing countries involves greater risk than investing in developed foreign countries. Dividends are not guaranteed and will fluctuate. Dividend yield is one component of performance and should not be the only consideration for investment.

CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA institute.

Santa Barbara Asset Management, LLC, is a registered investment adviser and an affiliate of Nuveen, LLC. Nuveen, LLC provides investment advisory services through its investment specialists.

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