Learning from Dividend Reductions

In July Codorus Valley Bancorp, a company that has increased their dividend annually each of the past nine years, announced that they were cutting their dividend by more than a third. Examining the warning signals that preceded the decision can be instructive in alerting us to some of the signs of an impending dividend cut.

On July 15, Codorus Valley Bancorp, Inc. announced a Quarterly Cash Dividend of $0.10 per common share, down 37.5% from its previous quarterly dividend of $0.16. After nine years of consecutive annual dividend increases, the company is no longer listed in the Dividend Challengers list.

A while back I profiled First of Long Island Corporation (NASDAQ: FLIC), a small bank in New York City. They should soon become a Dividend Champion, to date having increased their dividend for 24 consecutive years. By examining the metrics in the article about FLIC, we may be able to realize some of the indications that would have given a heads-up to Codorus Valley Bancorp’s announced dividend cut.

Gaining an understanding of success can help select companies that are beneficial to our portfolios. Articles fill the Internet offering such information, as is the case with numerous television shows. However, these sources are less than ubiquitous when it comes to taking note of failures in the making.

Perhaps this is because it is a much more difficult task. I hesitate to proclaim Codorus Valley Bancorp a failure because its dividend reduction may be what it needs to be a successful company in the future. Also, this measure of success may not be the same for different people. A company may be an excellent investment for one person but not another, as explained in Stock Tips are Bunk.

As a retiree, I have devoted a percentage of my retirement income to dividend companies, so a company’s dividend is an essential part of my definition of success and failure. My finances hinge on a company increasing its dividend, which is where I place my importance – your mileage may vary.

I will explore Codorus Valley Bancorp by using the same general concepts as when I examined First of Long Island Corporation. As can be seen, evaluating just a few elements of a company can give one a head start in fully understanding the future of its dividend.

Codorus Valley Bancorp (NASDAQ: CVLY) is a small company when compared to others on the major stock exchanges, with a market capitalization of only $125 million. It places the company within the definition of a micro-cap, a publically traded company that has a market capitalization between $50 and $300 million.

Before looking at the numbers, one must understand the potential difficulties associated with micro-cap stocks. They tend to be more volatile and riskier than larger companies, as large purchases have more potential to influence the stock price. It also makes them prone to market manipulation. These issues increase the risk, which may be counter to the idea of dividend investing in the first place.

Almost as important is that there is less information available about micro-cap stocks. Fewer analysts cover due to reduced interest, so events that may influence the company are more likely to go unnoticed. It makes understanding price movements and management decisions difficult, which complicates the decision-making process.

Price

Over the past ten years, CVLY’s stock price has had a long period of success, followed by a couple of declines. Starting at just under $4 in August 2010, it soared to over $28 in July 2018. Out of curiosity, I compared it with FLIC over that period, and on a price basis, it vastly outperformed.

The two companies mirror one another, with CVLY offering wilder swings due to its greater volatility, so this is a good comparison.

Dividend Yield

A dividend investor requires a dividend worthy of consideration, so that is always part of the calculation. Codorus Valley Bancorp historically offered a yield in the 2-3% range, which was comfortable. When the coronavirus hit, the price plummeted, which meant that the dividend yield shot up.

This yield spike moved it away from its comfort range, which under the circumstances is not a surprise. As the stock price was cut nearly in half due to the virus, the yield, as compared to historical standards, fell out of its traditional bounds. The dividend yield became atypical – not necessarily a cause for alarm, but a data point with which one should have taken note.

Dividend Payout

The dividend payout ratio compares the total amount of dividends to the net income of the company, that is, the percentage of the profits that go to the owners. A ratio that exceeds 100% tells us that a company is giving more to the shareholders than they are making, which is generally not sustainable.

According to CSIMarket, the average payout ratio for regional banks in 2019 was around 30%, then jumped to 52% in the first quarter of 2020, then fell to 40% in the second quarter. This tracks with Codorus Valley Bancorp, at least until this past June.

CVLY’s payout ratio had been remarkably consistent since 2017 when it shot up to 56% in June. Whereas this value had been closely aligned with other companies, it was now considerably higher. Usually, a payout ratios under 60% is not cause for concern, as it is sustainable. In this case, the near doubling in a short amount of time must have been a shock to the board of directors. It was also a data point to those holding the stock.

Dividend Growth

The June 2020 edition of the Dividend Champions spreadsheet shows a reasonable growth rate for Codorus Valley Bancorp, 12.5% over three years, 10.8% over five years, and 13.2% over ten years.

When the share price is low, adding one cent to the quarterly dividend can result in an impressive percentage increase. However, at times it appears that the company was increasing its dividend by the absolute minimum to show that it was, indeed, increasing its dividend. Note the ups and downs over six years – by some definitions of Dividend Champions, they should have lost their status in 2017. Below I have extended the dividend to six decimal places through necessity.

While Codorus Valley Bancorp was a Dividend Challenger and on track to move that designation up to Dividend Contender, note the increases and decreases, advancing and receding the dividend. It appears to have happened in fits and starts, as opposed to moving in a specific direction with energy.

Finishing Up

Dividend investors initially look at three things – yield, payout ratio, and growth – to gauge the condition of the dividend. These are not all-encompassing metrics that tell a complete story but are essential starting points that can act as red flags or go signs. Evaluating these three values in perspective with industry and history offer a starting point at divining future decisions of the board of directors.

In the case of Codorus Valley Bancorp, the dividend yield moved into uncharted territory when its price dropped and was not able to respond. The same happened with the dividend payout ratio, as it climbed into an area it had not previously seen. The company increased its dividend each of the past nine years, but that history does not extend to the beginning of the last recession.

The previous recession was not good for CVLY’s dividend. Its $0.14 dividend in January 2008 fell to $0.13 the following quarter, then $0.12 for the next three quarters before being slashed to $0.08, then finally $0.03. Some banks (like First of Long Island Corporation) were able to weather the storm, while others were not.

Dividend growth, when examined quarterly, appeared to advance haltingly. It was as if management grudgingly increased the dividend, not through desire but expectation. Despite the ability to increase the dividend, the will was absent.

With this knowledge, a shareholder should have seen the warning signs, known the company history during the last recession, and with the understanding that small companies have fewer resources to survive recessions, realized that a dividend cut was very probably on its way.

Sometimes dividend cuts take one by surprise, whereas other times they can be readily predicted. Paying attention to the described metrics and understanding a company’s history can prepare one for what is to come.