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Why the only way for Telstra Corporation Ltd to redeem itself is to cut its dividend

Shareholders of Telstra Corporation Ltd (ASX: TLS) cover your ears! The only way the stock can rally from here is for management to cut its sacred dividend.

The share price of Australia’s largest telco has been hammered to a seven-year low as the stock slipped another 2 cents to $2.84. The value of one of our most widely held stocks by retail investors has plummeted close to 50% over the past two years when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) has rallied 13%.

It may sound counterintuitive for Telstra to lower its dividend as that will trigger a revolt, particularly by income investors who are depending on the regular distributions.

But that may be the only way for Telstra to find its feet, in my opinion. I’ve seen this “death by dividend spiral” before when I was a reporter at Fairfax Media Limited (ASX: FXJ).

Fairfax was insisting in 2012 that it didn’t need to cut its dividend even as it was struggling to arrest the decline in profits. The market didn’t believe management and guess who won?

The intense pressure on Telstra’s share price in more recent times is driven by market expectation of a dividend cut and until management announces one, the stock will remain under selling pressure (including by short sellers) just as Fairfax was back then.

The share price of Fairfax bottomed only after the dividend cut was announced and I believe the same will be so for Telstra.

Sometimes it’s prudent for a company’s board to cut the dividend not because it can’t afford to pay one, but because it’s the right thing to do to rebuild confidence in the market.

The only other way for Telstra’s share price to rebase and re-rate is for management to surprise investors with a stronger than expected profit outlook, but I won’t be holding my breath for that.

This means retail investors should just get comfortable with a dividend cut because I think Telstra is only worth buying after that elephant has left the room.

In case you are wondering, I did buy Fairfax shares after the dividend cut and sold it when the share price doubled. I would be tempted to do the same for Telstra.

But it isn’t only Telstra that is under a dividend cloud in my view. I suspect some, if not all, of our big banks that include Commonwealth Bank of Australia (ASX: CBA), Westpac Banking Corp (ASX: WBC), National Australia Bank Ltd. (ASX: NAB) and Australia and New Zealand Banking Group (ASX: ANZ), may face this very dilemma in the not too distant future.

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Motley Fool contributor Brendon Lau owns shares of Australia & New Zealand Banking Group Limited, National Australia Bank Limited, and Westpac Banking. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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