How to Avoid Dividend Cuts

Not all dividends are created equal. How can you distinguish between a safe dividend and one that could be cut? I use Dream Office Real Estate Investment Trst (TSX:D.UN) as an example.

| More on:
The Motley Fool

You’re reading a free article with opinions that may differ from The Motley Fool’s premium investing services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Dividend companies share profits with their shareholders by paying out dividends. This is income that shareholders can use for whatever they want, whether that’s reinvesting it or using it to pay the bills.

However, companies aren’t obligated to pay dividends. In fact, they can cut or even eliminate them any time.

How can you reduce the likelihood of a dividend cut? Here are a few things you can do.

Is the yield sustainable?

Anytime you see a yield higher than 7%, you should question whether that distribution is safe or not. However, just because a company pays a yield of, say, 5%, that doesn’t automatically make its distribution safe either.

Dream Office Real Estate Investment Trst (TSX:D.UN) yielded more than 20% in 2008. However, it maintained its funds from operations (FFO) per unit and its distribution throughout the recession.

In 2015 Dream Office’s adjusted FFO payout ratio was more than 100%. So, fundamentally, it was impossible to maintain its distribution unless it borrowed or used the distribution-reinvestment program as a cushion.

The real estate investment trust ended up slashing its distribution by a third in February this year.

money, cash, dividends 16-9

Is the management willing to maintain the dividend?

Even when a company’s payout ratio is well below 100% and sustainable, the management can still choose to cut it. In the case of Dream Office, a part of the reason for cutting the distribution was to improve the company’s balance sheet.

Investors can look at a company’s distribution history as an indicator of a cut. Although Dream Office maintained its distribution throughout the last recession, it has hardly increased its distribution. (But, to be fair, most Canadian REITs don’t have a consistent record of growing their distributions every year.)

If you were to compare two companies in the same industry that have sustainable payout ratios, the one that has a history of hiking is distribution offers a safer dividend because that shows the management’s commitment to the dividend.

How much margin of safety is needed?

Some investors think of dividends as a cushion against the downside; they’re still getting a positive return when share prices decline.

That’s true to an extent. However, just because you decide to invest in a dividend stock doesn’t make it less essential to buy it at a reasonable (or even discounted) valuation.

In fact, the higher the yield of a stock, the bigger margin of safety you should ask for. Why is that? Typically, high-yielding stocks have little to no growth.

That’s because they are paying out most of their earnings or cash flows. So, there’s little capital left to reinvest into the business for growth.

From 2005 to 2015, Dream Office’s FFO per unit increased by 8%. That equates to annualized growth of only 0.78%. No matter how enticing its yield is, investors should wait for a big margin of safety (of at least 30%) due to its slow-growth nature.

Bank of Nova Scotia gives Dream Office a 12-month price target of $19 per unit. A 30% margin of safety implies a price of $13.30 per unit.

Summary

To avoid dividend cuts, investors should look for companies with sustainable payout ratios. And management must be committed to maintaining or, better yet, increasing the payout. Moreover, the slower a company grows, the bigger the margin of safety investors should ask for.

Should you invest $1,000 in Dream Office Real Estate Investment Trust right now?

Before you buy stock in Dream Office Real Estate Investment Trust, consider this:

The Motley Fool Stock Advisor Canada analyst team just identified what they believe are the Top Stocks for 2025 and Beyond for investors to buy now… and Dream Office Real Estate Investment Trust wasn’t one of them. The Top Stocks that made the cut could potentially produce monster returns in the coming years.

Consider MercadoLibre, which we first recommended on January 8, 2014 ... if you invested $1,000 in the “eBay of Latin America” at the time of our recommendation, you’d have $20,697.16!*

Stock Advisor Canada provides investors with an easy-to-follow blueprint for success, including guidance on building a portfolio, regular updates from analysts, and two new stock picks each month – one from Canada and one from the U.S. The Stock Advisor Canada service has outperformed the return of S&P/TSX Composite Index by 29 percentage points since 2013*.

See the Top Stocks * Returns as of 3/20/25

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Kay Ng owns shares of Bank of Nova Scotia.

Confidently Navigate Market Volatility: Claim Your Free Report!

Feeling uneasy about the ups and downs of the stock market lately? You’re not alone. At The Motley Fool Canada, we get it — and we’re here to help. We’ve crafted an essential guide designed to help you through these uncertain times: "5-Step Checklist: How to Prepare Your Portfolio for Volatility."

Don't miss out on this opportunity for peace of mind. Just click below to learn how to receive your complimentary report today!

Get Our Free Report Today

More on Dividend Stocks

TFSA (Tax-Free Savings Account) on wooden blocks and Canadian one hundred dollar bills.
Dividend Stocks

Here’s Exactly How a $20,000 TFSA Could Potentially Grow to $200,000

Index funds like the iShares S&P/TSX Capped Composite Index (TSX:XIC) are tax free in a TFSA.

Read more »

Dividend Stocks

How I’d Invest $6,000 in Canadian Real Estate Stocks to Build Lasting Wealth

Canadian REITs on sale! See how grocery-anchored retail properties offering 9% yields could turn $6,000 into lasting wealth despite US…

Read more »

rain rolls off a protective umbrella in a rainstorm
Dividend Stocks

Economic Headwinds: Should You Still Consider Buying the Dip?

A market dip might seem like a bumpy road, but it can be far smoother in the future with the…

Read more »

e-commerce shopping getting a package
Dividend Stocks

Consumer Spending Plays Amidst the Current Market Dip

Consumption may go down in market dips, but certain consumer stocks are certainly better off than others.

Read more »

Asset Management
Dividend Stocks

12% Dividend Yield! I’m Buying This TSX Stock and Holding for Decades

Stocks with high-dividend yields carry risks. But they could be a good long-term investment. Here is a 12% dividend stock…

Read more »

Canadian flag
Dividend Stocks

How I’d Build a Foundation of Canadian Value Stocks in My Investment Strategy

Canadian investors can explore iShares Canadian Value Index ETF for value stock ideas to build a foundation for their diversified…

Read more »

Canadian dollars are printed
Dividend Stocks

How I’d Transform a $30,000 TFSA Into a Cash-Flow Machine

Here's why TFSA investors should consider owning dividend stocks such as Mullen Group in 2025.

Read more »

A woman shops in a grocery store while pushing a stroller with a child
Dividend Stocks

Dip Buyers Could Win Big in Today’s Market Dip

If you want to buy the dip, think long-term. Which is why this TSX stock is a top option.

Read more »