Speed Reading Earnings Report: Beyond The First 60 Seconds

This is a continuation of my previous post: How To Speed Read An Earnings Report In 60 Seconds Or Less

Assuming you did the first 60 second read of the earnings report and still didn't get a warm fuzzy feeling for the dividend safety. Well, now you have to spend a bit more time digging into the report.

But fear not. I promise, you can still get through the earnings report in less than 15 minutes and get to a reasonable conclusion about the dividend safety. You do this by simply extending your word search in the earnings report and paying attention to the management's use of words to describe dividends.

Search (CTRL+F) for the word 'Priority'

I only pay attention to the word 'Priority' within the context of dividend.

When management starts using the words like 'high' or 'top' with 'priority' to describe their dividend policy, it generally means there are concerns about dividend safety and the management is trying to calm the nerves down.

The word 'Priority' is a bad word when used with dividends 

I like to go back a few quarters to see how management used the word 'priority' to describe a dividend and if there are any subtle changes to this so called priority in an earnings report.

I would open up the past earnings reports in multiple windows side-by-side, and look at the sentences used to describe the dividend priority and pay special attention to the words that come before and after 'priority' and the order in which they are used.

An example of how a management can gradually and subtly degrade the dividend priority from one quarter to another

Mattel's Q3' 2016 earnings report (strong wording with dividends first in the statement):
"And dividends remain our first priority after re-investing in the business..."

Mattel's Q4'2016 earnings transcript (note the additional word 'also' which implies there are other first priorities besides dividend):

"Dividends also remained our first priority after reinvesting in the business..."

Mattel's Q1'2017 earnings transcript (note the mention of dividend priority has moved to the second fragment of the sentence, clearly implying lower emphasis on dividends):

"After reinvesting in the business, dividends remain our first priority."

Mattel's Q2'2017 earnings transcript (note how dividend is described as a second priority instead of first.):

"Our second priority after investing in the business is to continue to reward our shareholders with a dividend."

This is where I would be certain that dividend is not safe and would either trim or sell the position before the stock price and dividend takes a hit.

Surely, Mattel cut its dividend in Q3 of 2017.



For an Extra Credit:
Search Words: M&A, Spin-off, Capital Allocation

Does company have any plans for mergers or acquisitions or spin-offs? 

Such activities could have impact on future dividends depending on how the company plans to raise cash for the M&A or in the case of a spin-off, how the dividend policy would be effected after a change in cash flow?

For example, it was known for at least two quarters that HCP management was looking into spinning-off its troubled SNF facilities due to trouble with its two largest tenants, and it would result in resetting of dividend payout.

Lack of clarity in dividend policy post spin-off

In the case of HCP, questions started to show up in the quarterly transcripts from analysts regarding the post spin-off dividend. I didn't see much clarity in the responses that management gave. Also it wasn't clear how much dividend the new company would pay after the spin-off.

Feeling of uncertainty

There was just too much uncertainty around the HCP dividend in pre-spin-off talks and I wasn't getting the warm and fuzzy feeling from what I was reading in the earnings transcripts prior to the spin-off.

Get-out while you can

I pulled the plug before the HCP spin-off and saved myself from a dividend cut and a 30% price decline.

Soon after the spin-off, HCP announced the new dividend which was actually a cut, and the new spin-off company never paid a dime in dividend. Therefore, investors who decided to keep HCP shares through the spin-off got a big dividend cut in addition to a depressed stock price that has still not recovered and were left holding the bag of an unproven spinned off company that didn't pay any dividend.

Moral Of The Story

Don't let the management pull a fast one on you by telling you that dividend is safe when it isn't. Read between the lines and look for clues to see behind the smoke and mirrors. You will get better at it by knowing what to look for in an earnings report and by paying attention to how certain words are used to describe dividends in an earnings report.

Disclaimer: Author of this article is not a licensed/registered financial or investment adviser and does not provide investment advice. Any mention of stock names/tickers in this article or website is not a recommendation to buy or sell. Please do your own due diligence before buying any stocks. This article is for informational and entertainment purposes only. Full disclaimer can be read here: Full Disclaimer

Comments

  1. Good stuff Mr. ATM. I'm sad to admit that I endured both the MAT and HCP reductions. DOW recently did the same as HCP as part of it's merger with DuPont. I refer to HCP and DOW (now DWDP) as "back door" dividend cuts as often they are misrepresented by management when they are announced as new dividend policy rather than announced as the outright reduction they really are.

    That said, HCP and MAT were very small holdings. I got greedy chasing high dividend yields when I made my small initial purchases. As time passed, I did not make any add on buys for fear of a dividend reduction. Trying to learn from mistakes, my reaction over the past few years has been to de-emphasize current yield and emphasize dividend growth potential with new stock purchases.

    My question for you is: Do you review every 10-Q for every company you own or plan to invest in? I do not and am deficient that way as an investor. This is why I like your last 2 posts on how to efficiently go about reviewing quarterly reports as it related to DGI.

    Tom

    ReplyDelete
    Replies
    1. Good Morning Tom,

      I have also endured the pain of a few dividend cuts during my earlier part of investing career. Since then, I focus more on dividend growth and other safety metrics than just the high yield, as you also stated. Time is a good teacher.

      As for not buying any more of HCP and MAT, that was a good call on your part. I also owned MAT but got rid of it when it was clear that FCF was not going to cover the dividend and they would have to take more debt. I took a small loss, but nothing like what other people endured a year or so later when MAT cut its dividend and eventually suspended it all together.

      Another warning sign for dividend is when a new CEO takes control of a troubled company. The new CEO may not think twice to cut or even completely suspend dividend. He/she would want maximum flexibility in capital allocation to turn the company around and no body would blame him for breaking the past management's promises.

      I think that was the case with GE. I hope it doesn't happen, but I wouldn't be surprised if Flannery completely suspends the dividend.

      Regarding your question related to 10-Q, I use two different processes depending on whether I already own the company or if it is a new position I'm considering to own or build-up.

      For existing positions, I simply follow the process I've noted in the last 2 posts. I have 40 some positions, so this process works nicely for me and saves a lot of time.

      For new positions, if they pass my initial screen in step 1, I would spend considerable amount of time going through company/research material. In a nutshell, here is what I do in this exact order:

      1. Screen the company using FastGraphs (this is my go-to tool). It tells me what the fundamentals(eps, FCF, payout ratios, credit ratings, dividend growth, etc.) look like. It also gives me an idea of a fair value.

      It takes me no more than 10 min to do this screen. If the stock passes the screen than it makes it to my watch-list and then I can work on further research.

      2. Read the latest investor presentation from company's website to get familiar with the company and their products and the market they play in. I also focus on what company says about their dividend policy. I like to see company brag about dividends in those presentations. Next, I check for any issues outlined in the presentation and any future projects.

      3. I open latest quarterly earnings transcripts and head straight over to future guidance and analyst's questions. If guidance is positive, the stock should do well going forward. Analysts will poke into issues, so I want to understand the current issues and what management is doing to fix them.

      4. I also read the latest CFRA report and Morningstar for their Fair Value estimates, just to crosscheck against FastGraphs.

      5. I set my buy price and yield targets and wait for the stock to come to me.

      Once I have started a position, I would work on building the position up on strength but limit additions on a weakness to no more than 2% of cost as I don't like to catch a falling knife.

      Believe it or not, both of these processes have worked very well for me and I continue to tweak and improve upon them.

      Always a pleasure to see a comment from you Tom.

      Take care and happy investing.

      Delete
  2. Thanks Mr. ATM. Very complete and insightful process. It could be a blog post in and of itself. Tom

    ReplyDelete
  3. I'm not used to paying this much attention to the wording in the reports. But interesting to see your example with Mattel. I'll keep this in mind. Thanks for sharing!

    ReplyDelete
  4. I'll be book marking this for future use Mr ATM! I'm sorry for my delayed comment, I didn't even realize that you had a new post.

    I have also noticed that if companies go out of their way to tell you that the dividend is safe, it likely means that it isn't. My biggest lesson on that was KMI a few years ago. That was a painful one but I learned a lesson. It also taught me to keep an eye on companies debt.

    ReplyDelete
    Replies
    1. No problem DS, a delayed comment is better than no comment, besides I always appreciate hearing from my blogger friends.

      Yes, KMI is a lesson for the books. It was a widely held stock among dividend investors (thankfully I didn't own it) and in 2014 management promised 15% div annual increase in 2015 and 10% growth from 2016 to 2020.

      However, in the Q3'2015 (one quarter before the massive cut) ER, management clearly said that their dividend coverage has taken a substantial hit, and would expect to cover a dividend that is 6% to 10% higher than the previous year. FCF was clearly not covering the dividend at the time, that was a big warning as well.

      So, as you can see, they were trying to scale back the expectation on dividend growth in Q3 ER and then in Q4 they dropped the big hammer and slashed the dividend all together.

      There wasn't enough warning like Mattel, but there was still warning signs in the previous quarter.

      Yes and company's debt is very important which ties into their credit ratings. Most companies would rather cut the dividend than take a hit on their credit rating. And when a company is already at the bottom of the 'investable grade' credit rating of BBB- , there is really noway out but to cut the dividend and safe the rating.

      This is what S&P said after re-afirmming KMI's credit rating of BBB- after dividend cut:
      "The rating action reflects our view that KMI's dividend adjustment is credit positive and a prudent and necessary action taken by management in light of very challenging capital market conditions,"

      Credit ratings are very important and reflect the company's debt levels and why I pay attention to these ratings.

      Anyway, I love to do postmortems of these dividend cuts as I end up learning a lot from them. Thankfully, I've not had to experience a dividend cut in a while. I want to keep it that way.

      Take care

      Delete
    2. So far, KMI was my only really bad experience with a dividend cut. Cut may not be strong enough, does slash sound fiercer? One of my friends was in it a lot heavier than I was. I should add that it also taught me a lesson on proper diversification. I don't remember the exact percentage but it was a heavy weighting in my portfolio at the time.

      Live and learn!

      Delete
    3. Slash it was, a 75% dividend slash.

      Proper diversification is a must, and so is active monitoring of your position, no matter how high the convictions in the stock,

      Delete
  5. Very nice and informative article. I am definitely going out for these words in the future. Another dangerous word is "strategic alternatives". It basically means company is likely to file Chapter 11.

    ReplyDelete
    Replies
    1. Thanks dividendgeek. "strategic alternatives" sounds scary, hope I never have to read that in any of my company's earnings report.

      Thanks for stopping by.

      Delete
  6. Good stuff - I think it's key that investors look at the reports of the companies they own at least on a yearly basis and sometimes more often when it's not a rock solid company. One of the reasons I own so few individual securities is that I don't simply have the time to keep track of 60 stocks and decided whether they're still good investments.

    ReplyDelete
    Replies
    1. Hi,

      Yes, definitely time consuming especially when you have so many stocks. Yearly review is a great idea and also if one has done enough due diligence when buying a stock, it makes it easier to monitor it. So upfront effort is preferred than an on-going deep dive analysis, at least in my case.

      thanks for stopping by Timeinthemarket

      Delete
  7. Love it! Such a school-book example with Mattel. And another reason to invest in us companies. You can't search like this for nor,swe or other companies. They never talk about dividends this way, which is why aristocrat in sweden is about 10 years while it's 25 for you.

    ReplyDelete
    Replies
    1. Thanks Arne.

      Yes Mattel is a school book example and you would be surprised to see how often management follows the same pattern towards dividend cuts.

      Thanks for sharing about not, swe companies. Didn’t know aristocrat is 10 years there.

      That’s part of the reason why l mostly invest in US companies, management has to be much more open in discussing ER and analysts are aggressive in asking questions.

      Take care and thanks for stopping by.

      Delete
  8. Good content there Mr. ATM. I liked reading your first 60 seconds and this one that takes bit beyond as well. I personally pay attention to a few more criteria as well but then again only if I have more time than 120 seconds which is where your post is concentrated on. I also like to read notes to financial data and risk on the fist part of the report.

    I also try to spend more time on balance sheet which is available on website for a quicker review. I like your post and can use for future as well myself for a quick review.

    Good Luck,
    TDK.

    ReplyDelete
    Replies
    1. Thanks TDK, appreciate you stopping by.

      It’s great that you pay attention to additional metrics and balance sheet. I do the same but only for new positions or if there is a concern with an existing position.

      Glad you liked the post.

      Take care

      Delete

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