Distance to Default: Measuring Financial Health

Ivana asks about distance to default; Dan describes the metric using assets, liabilities, market signals and its predictive value.

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It might be tempting to buy dividend stocks with the highest yields, but not all dividend payers are safe. Those big payouts could be signaling that a company’s fundamentals are cracking. Looming financial risks could wreak havoc on income-focused investors’ portfolios. But there are ways to spot dividend traps. Morningstar Indexes strategist and columnist Dan Lefkovitz explains how to avoid the risks.

Both healthcare and consumer defensive sectors are lagging the broader stock market this year, but for different reasons.

Dan Kemp, chief research and investment officer at Morningstar Investment Management Europe, explored what’s behind it in this week’s Markets Brief column. He says consumer defensive stocks are falling from high valuations, while healthcare stocks are facing significant headwinds like politics and earnings growth. He reminds investors that’s why it’s important to understand not only what you own in your portfolio, but why you own it as well.

On this episode:

What is a dividend trap, and under what conditions do they tend to develop?

You and your team published research on dividend traps just before Dow Chemical DOW cut its dividend in half over the summer. How does your research explain what happened with Dow?

Other well-known brands have also slashed their dividend payouts since 2020. The list includes Shell, Walgreens, and Intel. What warning signs were these companies flashing before their cuts?

You have written about how income-focused investors can avoid dividend traps. Let’s start with step number one on how to spot them. What is the payout ratio, and what does it tell us about a company’s health?

The second step focuses on a company’s durable competitive advantage or economic moat. Can you describe what that reveals?

Your team weeds out dividend payers using a third step that relies on Distance to Default. How does that work, and what did you all find out?

How can investors protect their dividend income from risks? Would portfolio diversification help?

What’s the key takeaway to spot dividend traps?

We discussed on last week’s Investing Insights that you would focus on the market moves following the Fed’s quarter-point cut. How have the US dollar and bond prices reacted?

In this week’s Markets Brief column, you zoomed in on the lagging performance of healthcare and consumer defensive stocks. What’s important for investors to know?

New data on inflation from the Fed’s preferred tracker is set to come out Friday, September 26th. Inflation is hovering above the Fed’s 2% target. What are the markets’ expectations, and what would a surprise in the data mean for the near future?

Read about topics from this episode.

Not All Dividend Stocks Are Safe. Here’s How to Avoid Dividend Traps

What Investors Can Learn from Dow’s 50% Dividend Cut

7 Things You May Not Know About Dividends

The 10 Best Dividend Stocks

Does Dividend Investing Still Work?

Construction Rules for the Morningstar Indexes Distance to Default

Markets Brief: AI Investment is Massive in a Cyclical Industry. Will This Time Be Different?

What to watch from Morningstar.
Should You Hold Cash Investments After the Fed Cuts Interest Rates?

What You Need to Know Before Choosing a Stock ETF

Investing in AI? Here Are 6 Undervalued Stocks for Buy-and-Hold Investors

Do Dividend Stocks Benefit From Non-US Revenue?