The US pipeline giant Kinder Morgan cuts its dividend by 75% during the second week of December and this was a big change from years of growth and increasing dividend payments. Kinder Morgan arose from the days of Enron who sold the pipeline division to concentrate on other things. The pipeline was taken over by Richard Kinder and others and made Mr. Kinder a billionaire. For many years, it has been a great investment with a rising dividend. John Heinzl who writes in the Globe and Mail offered some lessons from the reversal. The lessons are:

1. A rising dividend alone does not guarantee anything

One of the analysis is to ask if a company not only has a dividend but raises the it and what is the expectation of raises in the future. The rising dividend can be a very good sign if it is supported by growing cash flow and earnings, a healthy balance sheet and favorable business outlook. If those things can change, then the story has a different ending.

2. High yield = high risk

In September, Kinder Morgan’s yield was 6.3%, by the time of the cut in dividend the yield was 13%. When the relative yields at the bank are much lower, the stock market is telling you something.

3. Payout ratios matter

Through the first 9 months, Kinder Morgan made 1.58 a share and paid out 1.42 in dividends, the ratio was 90%. Common sense tells you 90% for you, 10% for the company is not a good balance. The 10% left little money for reinvestment into the company and seeking new opportunities. Something had to change.

4. Debt ratings matter, too

Kinder Morgan’s bond rating was getting close to junk status. A pipeline can not operate on junk status, they needed to increase the rating and one method was a dividend cut.

5. Don’t count your dividends

Project your dividends, but do not spend them until they have been declared by the board and the money spent. Boards can change their minds.

Linking to dividend paying stocks, while we all look for simple methods to determine which of the many companies we wish to buy and hold, the financial health of the company remains  the reason why you need to do your homework.

There are more questions than answers, till the next time – to raising questions.