This article originally appeared on The Div-Net on November 24, 2011
There are many articles out there explaining the best ways to purchase dividend growth stocks. You can read all about buying based on dividend growth history, valuation, debt load, economic moat and many other criteria. But, there aren’t many times you’ll hear about selling dividend growth stocks. There is a good reason for this. The main reason is that most dividend growth investors are long-term investors for the most part. When we, as dividend growth investors, purchase shares in a company we do so because we believe in the long-term health and fundamentals of the company. However, things change over time and it’s in your best interest to monitor your positions and adapt to the changing business world. That occasionally means selling a position, if warranted.
- The fundamentals of the company have changed.
- The dividend has been held static for two years in a row, or has been eliminated/reduced.
- The stock has become grossly overvalued.
In my view, these would be the only real reasons you would want to sell all, or part, of a position in a dividend growth stock. If the fundamentals of the company have changed, such as the market share eroding, the earnings/revenue declining, the economic moat disappearing or management making errant decisions then it might be in your best interest to seek opportunities elsewhere. Businesses change over time, and the reasons you first invested in a company may no longer apply. In that case, it may be best to sell that position and redeploy that capital in better opportunities. Never fall in love with a stock. I promise you that will be a one-way relationship.
If the dividend is held static or, worse, cut/eliminated than this is an obvious cue to a dividend growth investor to get out and move on to a company that can continue to grow the dividend. The main tenant behind dividend growth investing is to invest in companies that can grow their dividends through increasing revenue and earnings. If the dividend is cut or eliminated that gives an investor an indication that the company can no longer increase earnings and revenue in the near future while still paying out a dividend. In most cases I’ll sell a position that is paying me a reduced dividend or no dividend at all based on my investment philosophy. The only way I wouldn’t do so is if I feel the company is still very healthy and is just going through a very short-term headwind and needs the additional capital to stay healthy. I wouldn’t want a company to continue to pay a dividend just for the sake of doing so if it’s going to hurt the long-term prospects of the company. On the other hand, most companies I invest in have healthy payout ratios and can withstand short periods of economic duress.
If a stock has become grossly overvalued due to a market run-up, this may give a dividend growth investor a great opportunity to book in some profits and use that profit to fund an investment into an undervalued dividend growth equity that has been ignored or unfairly punished by the markets. The markets are far from efficient in my opinion, and there are companies that are undervalued and overvalued on a regular basis. I would only consider selling an equity due to this criteria if I feel that the stock is almost ridiculously overpriced and due for a massive fall. In that case I’ll likely sell my position and wait for a more attractive entry point down the road. You need to have a good idea of what the intrinsic value of the stock is before selling in this case.
What is most important to remember here is why not to sell a dividend growth stock. If the price of a stock falls dramatically in a short period of time, this is often NOT a reason to sell a position. You have to keep a cool head and remember the reasons you invested in the company. If the fundamentals remain the same, the dividend is in no danger, earnings and revenue appear to be growing and the valuation is attractive this is more often than not an opportunity to average down and lower your cost basis on a position. If, however, the market is is exiting a stock because of serious issues this would be a good opportunity to review the company’s financial information and make sure the long-term health is intact. If it’s not, then one of the above three criteria likely apply and you’ll likely want to sell and redeploy that capital.
What about you? When do you consider selling a dividend growth stock?
Thanks for reading.