First Niagara Financial (NASDAQ: FNFG) was kind enough to teach me two dividend lessons through one scary story.
The story is the biography of First Niagara's CEO John Koelmel. Koelmel, who started at First Niagara in 2006, was on an acquisition spree (New Alliance, Harleysville, HSBC) from day one and had used increased EPS to pump up the dividend from .40 to .64 in four short years.
Sound good? I thought so too, yet soon after I decided to jump aboard the story quickly deteriorated. The red flag that went ignored: at the time of their HSBC branch acquisition in 2010, FNFG's pay-out ratio was a ridiculous 75%.
Surprisingly FNFG decided to issue new stock and dilute shareholders to fund the acquisition. If that move weren't curious enough the next was startling; with bank stocks (including FNFG) slumping, Koelmel & Co. decided to slash the dividend 50% and take on pricey debt, just to fund the acquisition.
The truth is that the company couldn't grow organically, and it needed acquisitions to grow EPS in order to pay its unsustainable dividend. The lesson from this is to stick to organic growth stories with payout ratios under 50%; both alternatives are screeching red flags