When To Sell A Dividend Growth Stock

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.

In my opinion, there are three main reasons one would want to sell a dividend growth stock:

  • 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.

Comments

  1. says

    The first and third points are applicable to non-dividend stocks as well!

    But these three rules are good rules of thumb to follow. Just don’t sell a stock because everyone else is doing!

  2. Oculista says

    Three simple points.

    Easy to use on US stocks but not so easy in other markets.

    Some of the best dividend growth stocks in Europe like Reckitt Benckinser or Inditex paid the same dividend for 2 or 3 years before starting or continuing strong dividend growth trends.

    Hugo Boss is another special case. They paid a special dividend five times bigger than the normal dividend two years ago but had to cut the normal dividend later. The special dividend was forced by the private equity that controlled the company in order to improve the leverage of parent company. Nowadays they have grown distributions enough to recover the former trend.

    Also some Latam stocks (like Ambev) have not meet the three above criteria strictly. Some years they have paid 1%-3% less than the previous year but they increased the payout strongly those years in an effort to try to minimize the impact on their dividend track record and finally managed to continue their normal growth after that.

    You are very lucky because US companies tend to have more tradition of dividend growth but in foreign markets you should be more flexible with your criteria or you will lost some of the best opportunities.

  3. lazyfabs says

    What about a company like GE? Would you still apply the same principles?

    Enjoy reading your blog. Continued success.

  4. says

    Good post. My goal is to keep stocks longterm but ive sold quite a few positions the last year.

    For most of my exits the company fundamentals and valuation has remained roughly the same but ive reconsidered the positions as my knowledge has grown. Hopefuly this pattern will stop when my mindset becomes more mature.

  5. says

    What is consider grossly overvalued? Is it a 50%, 100%, etc. run up? This gets mention quite frequently, but no one provides an exact range when to sell.

    I think if the company’s fundamentals are sound, why not keep the stock? You can potentially lock in a ten-bagger.

    My parents bought UTX in 2000 and continued to reinvested the dividends. They have a 600+% gain. UTX will probably continue to increase its dividend and the stock price might even appreciate in this horrible economy.

    Plus if you sell, then there’s the issue of taxes. Just my two cents.

    But I do agree with the first two points. Great post DM! =)

  6. Debbie M says

    @defensiven, good point. Changing your mind as you learn more about what strategy you’re using is definitely a good reason to sell.

    @Henry, my guess is that when the stock is so overvalued that you could easily find another stock to replace it with cheaper (including taxes and buy/sell fees), that’s a good time to sell–you should be able to increase your dividend yield. I agree that selling and then waiting to re-buy the same stock hoping it will go down is just risky.

    When all the stocks are overvalued, it gets trickier.

  7. says

    DM this is a good question, from my point of view I don’t have a single answer. I own stocks that have had limited dividend increases but I chose to still own them because the story is playing out. Also, I own some companies that have the best management and businesses that I don’t want to let go because I know they are winners, my “core” holdings.

    But even then I can be persuaded to sell my core stocks. I sold Realty Income(O) for $35 because it had become too expensive (growth was 2-3%, valuation was 17X cash flow)

    The standard way to determine if a stock is overvalued is to compare its valuation to its inherent earnings growth rate. If it’s greater than 2X, then this indicates overvaluation.

    This can get murky because the cyclicals (such as ETN, CAT) have been all over the place with “earnings growth” because nobody knows what economic cycle we are in right now.

  8. says

    Money Cone,

    Great point there. If you’re selling just because that’s what the herd is doing you’re likely going to be selling for the wrong reasons. If you follow the herd you’re eventually going to get stomped on.

    Thanks for stopping by!

  9. says

    Oculista,

    Thanks for adding that. Great points made there.

    I agree that these rules mostly apply to U.S. based equities as our companies are a bit different in regards to dividend payouts. Our companies tend to pay smaller, quarterly payments and commit to raising them 7-15% per year. European stocks, for example, tend to pay higher dividends that are usually semi-annual payments more closely correlated to earnings so they do fluctuate a bit more.

    I agree that these rules would have to be more flexible for a global investor. For instance, I do hold Total S.A. (TOT)(ADR), which isn’t a dividend growth stock, but does pay out a healthy dividend and has a pretty steady business. I originally invested in them when I was just starting my investment philosophy, so I still hold them.

    Best wishes!

  10. says

    lazyfabs,

    Thanks for stopping by. I appreciate your encouragement and compliment. I hope you stick around and stay in touch.

    Per GE, if I owned them before the dividend was cut I would have sold at the first sign of trouble. They have since restructured their business, especially on the GE Capital side. They are looking more attractive now, but the debt load is still too high in my opinion. It looks like a decent play because it’s cheap and the yield is very high for a company like GE. But, again the debt load is going to have to be addressed at some point and you have to ask yourself it the dividend will be cut again at the first sign of global economic trouble. For now, I see more attractive fish in the sea.

    Best regards!

  11. says

    defensiven,

    Great comment there. I agree with you. With investing, you have to learn to roll with the punches and you will inevitably change your strategy and the way you invest over time. You’ll grow intellectually (hopefully), learn from mistakes and be able to better spot opportunities. This comes with experience. And, as you gain experience, I believe that perhaps selling a stock that no longer fits your investment strategy makes sense.

    One personal example I have is Total S.A. (TOT). As I referenced above, it was one of the first individual stocks I purchased and I bought it just as I was forming my dividend growth strategy. I bought it after the Deepwater Horizon went down in the Gulf of Mexico and it was cheap. I also bought XOM at that time. TOT really doesn’t fit my investment strategy any longer, but I still hold because it has a great dividend, a good business model and the stock is still cheap. But, at some point, I may sell simply because it’s not a “Dividend Mantra” type stock. Hopefully that makes sense.

    Take care.

  12. says

    Henry,

    Great question there. Thanks for adding that.

    Overvaluation relates directly to valuing a stock, and only you can ultimately answer whether you think a holding is grossly overvalued or not. I think it comes down to the same ratios as when I purchase. If a stock climbs to a P/E ratio of 30, when other stocks I hold are still in the ~15 range, and there is no giant growth catalyst on the horizon and this is a historically high ratio for the company, is it then overvalued?

    Hypothetical example: MCD climbs to $140 per share based on a great new menu item and growth overseas. It is now at a P/E ratio of 27.45 and has a yield 2%. Meanwhile, I could sell those shares and purchase PEP for $64 per share with a P/E ratio of 16.07 and a yield of 3.2%. Is MCD overvalued at that point, and would selling it and purchasing PEP instead be a wise move? Only you can answer that, but ultimately I would probably make that trade. Of course, I’d have to be in that situation to really see what I would do.

    Hope that helps! Keep in touch. :)

  13. says

    Debbie M,

    Great stuff. I agree with you. When the whole market is climbing, it does get tougher to find out if individual stocks are overvalued or the whole market is overvalued. The joy of equities investing!

    Take care!

  14. says

    sfi,

    Thanks for adding that. Great points.

    You are referring to the PEG ratio, correct? Price to earnings growth? I refer to that as well. I usually like anything at 1 or below. But, as you pointed out, it’s hard to use this because it’s using numbers that are being extrapolated. It’s especially difficult for cyclical stocks, as you stated.

    Thanks for stopping by! Keep in touch.

  15. Anonymous says

    I have been a dividend investor for years, but am a bit wary right now for two reasons. Firstly, high yielding stocks have had a huge run over the past 20-30 years due to the decrese in interest rates over that period. These stock, are after all, somewhat of a proxy for bonds and look at the great return on bonds during the past two years. There is or will be substantial interest rate risk. Secondly, these stocks have become a crowded trade, and thats almost always a bad sign. My advice is to sell overvalued dividend stocks, reinvest some, but also start building a cash position. Comments?

  16. says

    Anonymous,

    Thanks for stopping by and commenting!

    I think if you compare valuations 10 years ago to what they are today I think you’ll find that a lot of major dividend growth stocks were overvalued 10 years ago and I see a lot of opportunity today. As far as interest rate risk, the Fed is pretty clear about their desire to hold the rate low for the next 2 years. Your advice to sell overvalued dividend stocks definitely holds true, but only when they are in fact overvalued.

    I also agree with your last point. I think it’s always a good idea to have a cash position, and although I try to have 5%+ in cash, I find it difficult to not be fully invested because I see so many companies I want to invest with. I guess I’m an optimistic opportunist. So many equities, so little cash!

    Best wishes!

  17. says

    From my experience the best time to sell a stock is when all the people in the investment community have nothing but great things to say about a company but nothing bad to say’ morning noon and night and after lunch. When all the investment pros are recommending that everybody buy the stock. When all the investment pros are in total agreement about a stock in a very positive way. When you see the company being talked about in a very positive way regularly on CNBC bloomberg and on every other financial news program. Than its time to sell.

  18. says

    Shares like Google and Apple are the ones that has to be sold, they are over evaluated. And shares like Chevorn and Exxonmobile has to be purchased as they value is low now.

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