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You Can't Control Dividend Cuts, but You Can Control What You Do About Them

Motley Fool - Sat Oct 7, 2023

If you are a dividend-focused investor, you will most likely experience a dividend cut at some point. Although a reduction in a dividend can hurt, rushing to make portfolio changes without understanding the reason for the cut could be a mistake. A quick look at the dividend reductions from Medical Properties Trust(NYSE: MPW) and Exelon(NASDAQ: EXC) helps to highlight why thinking through the logic of a cut can be helpful.

Medical Properties Trust hits the wall

Medical Properties Trust is a real estate investment trust (REIT) that owns, as its name suggests, medical properties, particularly hospitals. That said, REITs are designed to pass income on to investors, so dividends are really important in this sector.

In the second quarter of 2023, Medical Properties paid a per-share dividend of $0.29. In the third quarter, the dividend announcement was for $0.15. That's a nearly 50% cut, which is a huge reduction.

Scissors cutting a one hundred dollar bill in half.

Image source: Getty Images.

That dividend cut, however, wasn't a surprise. In fact, a Wall Street Journal article highlighted the REIT's troubles less than a week before management announced the cut. To simplify a much longer story, Medical Properties Trust had a number of large tenants that were struggling. Despite expressing confidence in its ability to deal with the headwind, it ended up in a financial situation with no choice but to cut the dividend and focus on strengthening its balance sheet.

In a situation like this, when a company cuts its dividend because of problems in its business, investors might very well want to get out. Often, the reality is that the writing was on the wall prior to the cut, so an early exit may have been possible for more active investors with a low-risk threshold. Regardless, selling makes a great deal of sense if a business has changed in a negative way and no longer lives up to the thesis you had when you bought it.

Exelon Energy makes a strategic shift

A very different story unfolded at Exelon Energy in 2022. Exelon is a regulated U.S. utility. The final quarterly dividend paid in 2021 was $0.3825 per share. The first regular dividend payment in 2022 was $0.3375 per share. That's a roughly 12% dividend reduction.

What happened was Exelon spun off a business now called Constellation Energy(NASDAQ: CEG). The move was basically an effort to simplify Exelon's operations so that it was a fully regulated utility. Regulated utilities are usually fairly boring and grow slowly. Investors looking for safe and reliable dividends often find regulated utilities attractive.

The Constellation spin-off is focused on clean energy and owns non-regulated assets that operate on the competitive power market. There's a growth aspect to this business as the world shifts toward cleaner energy sources. But selling power to other businesses is riskier than providing power under a regulated utility structure. The dividend reduction at Exelon basically reflected the revenue that went with Constellation Energy.

Notably, Exelon got right back to increasing its dividend. And Constellation pays a dividend, too. So, the story here is very different from what transpired at Medical Properties Trust.

If you owned Exelon because of its regulated utility business, there really wasn't a good reason to sell the stock after the cut. It simply became more of what you owned it for. If you liked the Constellation business, well, you still owned it because of the spin-off. If you didn't actually like Constellation, the spin-off gave you the option to sell that stock and get the business out of your portfolio. All in all, this was more of a win for dividend investors than it was a problem.

Avoid knee-jerk reactions

Emotions often run high when it comes to investing. It's understandable, given the financial impact a mistake can have on your future. But when it comes to dividend cuts, you need to make sure you don't react too quickly. Sometimes, the right choice is to sell and move on, but other times, a cut is not as bad as it first seems. The difference between the dividend cuts at Medical Properties Trust and Exelon shows exactly why you need to take the time to understand the situation before acting.

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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Constellation Energy. The Motley Fool has a disclosure policy.

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