When to Be Wary of a Dividend Cut?

With Home Capital Group Inc. (TSX:HCG) recently suspending their dividend, questions as to how or when the dividend became unsustainable have begun to surface. Many income-focused investors and those looking for yield have long picked Home Capital as a top choice for yield in a world of ever-lowering dividend yields among equity issues. With the yield now gone, investors will need to decide whether the underlying assets of the business are valued fairly by the market, and make their investment decisions accordingly.

Home Capital’s five-year average dividend yield sits at 2.23%, and at the time of the dividend cut, the yield was hovering around 17%. As the Canadian alternative lender’s depositors began to flee amid a number of scandals, the company’s share price decline affected the yield proportionately, making the yield seem ever more attractive as the stock got cheaper and cheaper.

The liquidity issues with Home Capital ultimately led the company to suspend its dividend; after taking a $2 billion emergency loan at an exorbitant rate, the company would have likely been in very hot water had it decided to keep paying its dividend rather than use the cash to shore up its balance sheet, which is currently under attack.

While this was, in my opinion, a very clear cut case of the market factoring in a dividend cut into the company’s stock price, some analysts and contributors have maintained their affinity for the company’s growing yield over the past months. Focusing purely on yield and other high-level metrics can be very dangerous, and any such analysis should be done in the context of the entirety of the firm.