When to Sell Dividend Stocks

Investors always look for the perfect formula that would enable them to purchase the best stocks at bargain prices, which would provide large capital gains over time and an increasing stream of dividend gains. One could line up one or several indicators in order to reach a buy decision. Selling a stock however, is what could ultimately determine whether you succeed or fail in the long run.

As a buy and hold dividend investor, I try to pick stocks that trade at reasonable levels, and then dollar cost average my way into the position. My holding period is forever, as long as certain prerequisites are met. I don’t set target prices at which to exit, as most often than not the market is either going to blast through this level and never look back. Furthermore setting target prices at which to sell would imply that I know when to sell high and that this “high” price will not be reached again in the foreseeable future.

There are three conditions that could make me sell the stock I am holding.

- Company is bought out by another company for cash or stock or it is taken private
- The stock takes a very high portion of my portfolio, relative to other positions
- Company slashes or eliminates its dividend.

I will focus my attention on selling when a stock that I own cuts or suspends its dividends. One of the main reasons why I would enter into a dividend stock is because I believe that the dividend would be increased over time, bringing my yield on cost upward to a comfortable double digit level. If a company maintains its dividend payment, without cutting it, I would still hold on to the stock. When the dividend is cut or suspended however, my goal of generating an increasing stream of dividend income is no longer valid. Thus, selling my whole position in this company is the best decision to make. Bank of America (BAC), Citigroup (C) and General Motors (GM) are three good examples that selling right after a dividend cut is a good strategy.

Next week I will discuss why I disagree with the notion that selling after a dividend cut is an example of buy high sell low.

Comments

[Chirag Amin:]

Good article.....I hold BAC and am in the same predicament....The reason why I chose to invest in BAC was because it was a strong company with a growing dividend. It obviously failed me when BAC decided to slash its dividend. I haven't been putting in more money in the stock, but instead am holding the stock to find a good exit point....

PFE is another company that I decided to invest in for the same reasons.....However, they decided to maintain their dividend instead of cutting it (although it would have been nice if they decided to at least up the divy by a penny or two....). I'm gonna keep with PFE because I maintain bullish on its long-term prospects given its very cheap valuation.

Jan 04 01:19 PM

[User 283977:]

I faced the same decision as you Chirag… Here is the reasoning that I used to make my decision…

BAC cut its dividend, but its still at 8.9%. That is a great dividend yield. BAC's yield was formally at 17.9% but that was an accidental dividend yield caused by the large stock price reduction. In fact, that 8.9% yield is still an accidental high yield. That is a red flag.

When BAC was selling at $50 per share it provided an average yield of 4.3%. I consider that as the normal yield for the stock. Holding the current dividend payment constant at .32 cents per share, the stock price required to support a yield of 4.3% would be $29.8. The next ex dividend date is in late February. I doubt BAC is going to double its stock price by then. So I think its more likely they will cut their dividend again in February.

Normally, I don't care much about a stocks price when I am getting a good dividend return. However, I don't want to lock up a lot of capital in a stock that is going no where and that based on historical data seems likely to cut their dividend again. Given that we just passed the Ex Dividend date, I took my 8.9% dividend and sold my BAC.

I lost money on the deal, but I felt I could make better use of the money I got from the sale to purchase some stocks with better future prospects then those faced by financial stocks. Good luck with your decision.

Jan 04 03:21 PM

[Glitch:]

This isnt a case of "buy high, sell low", its a case of basing a decision on what happened yesterday rather than what happens tommorrow. That the dividend payout was higher yesterday is irrelevant to whether the stock is worth holding tommorrow.

You still walked away from a 8%+ yield. Unless you moved that investment money into another option with a similar dividend yield, this move was made purely out of spite. In fact, to continue 'growing dividends' and replace the income BofA cut, you'd have to reinvest the proceeds in a stock with a dividend yield around 18%. Good luck with that.

Punishing BofA for cutting their dividend in no way helps you going forward. Sell it because you dont like the business's future outlook or because other investments offer more potential or because some other stock will pay you a higher yield, but dont sell just because it is paying you less. Good investments are only "good" in relation to the alternatives, and BofA's 8% yield is still near the top.

And unlike Bob - who does state a good case in his post - I dont think BofA will cut their dividend any further, atleast anytime soon. Cutting a dividend hurts a compay's reputation, cutting a dividend twice in less than a year will devistates it. I believe the first cut was made to a level they were confident they could maintain going forward. Any further cut will be due to a lack of available cash, not because the yield is 'too high'.

Jan 04 05:22 PM

[grbn:]

selling BAC, C, and GM "right after the dividend cut" must have resulted in significant losses. You should have sold sooner, when the writing was on the wall, like for C. Waiting for the div cut to be announced is too late. Your sell criteria ignores other obvious reasons to bail.

Jan 05 07:26 AM

[SteveTheHawk:]

I've never owned C or GM stock (thankfully), but I have had BAC in my portfolio at times. The last time I sold at about $38 because I suspected a dividend cut. I suspect yet another is coming down the pipe. Credibility issues or not, BAC may not have a choice.

I'm not yet anxious to own this stock again. I think there are a lot of trolls hiding under the bridge still. I may consider taking a very small position, but likely not. I don't think they are out of the woods yet.

Jan 05 08:37 AM

[Boubou:]

I have done the same thing with my shipping stocks. They make no senses without a dividend. When i sold them they all declined further,which made me feel better about the decision.

Jan 05 08:47 AM

[Dividend Inc:]

Greetings Dividend Growth Investor,

The question of dividend cuts is fascinating since it is actually a potential buy signal rather than a sell signal. All dividend cuts take place after the stock has taken the largest portion of the declines that are likely to occur (in the short and medium term.)

A dividend cut reflects the company management's realization that action needs to be taken in order to shore up the company's finance. Once the cut takes place, an investor can then fairly assess the potential for a healthier balance sheet.

Another method for avoiding the decline in dividend paying stocks is to sell when the stock is selling at a historically low yield and buying at a historically high yield. This keeps the perspective on the company in relative terms rather than trying figure out when management is going to make the tough decision to cut the dividend long after the decline has taken place.

Some good sources for understanding this and other key dividend investing concepts without having to do the work yourself is found in the Investment Quality Trend newsletter (www.iqtrends.com). In their newsletter, IQTrends gives you the historical high and low yields for over 300 high quality dividend paying stocks. Another good source is the book Relative Dividend Yield by Anthony Spare and Nancy Tengler. Finally, my all time favorite is Mergent's Dividend Achievers (mergent.com/productsSe...) as recommended by Peter Lynch in the book Beating the Street.

Because of these sources of information, I had a great 2008 and I think that they will benefit anyone who takes careful consideration of the ideas contained within. Enjoy.

Touc
Dividend Inc.
www.dividendinc.blogsp...

Jan 05 01:29 PM

[levin70:]

I would also add that if a company takes on debt to maintain the div - that is also a good signal to exit

Kind regards

Jan 05 02:35 PM

[hwood007:]

I still own BAC. Sold some at $25 recently. I needed some money to help a family member and selected BAC for the paper loss I already had. When the emergency was over, bought it back 40 days later at $12. I have also bought some others which are up an average of 17.5%. I think it it an OK time to buy things like NSC,COP,EGN, and UTX. If the market goes to heck in a hand basket, I will not need money anyway and will feed myself from my gardens.

Jan 05 04:52 PM

[Dividend Gr...:]

The problem with a dividend cut is that the current yield looks exceptionally good, but it is the yield on cost that is cut. For BAC if you bought it at 50 your yield on cost dropped from just over 5% to 2.5%. Once a company cut its dividend once, what stops it from cutting again? Some stocks like KEY or Citi cut their payment twice. Others completely eliminated it. The investors who held the stock after the cut were HOPING that the worst is over. In investing, the worst thing you could do is to hope - you have to decide your pain point and sell and have a clear mind.

As for BAC or Citi, i would much rather sell ( I never owned any) after a dividend cut and end up with something left, instead of hoping it will go up someday or that I should invest in something that should be generating a 10% current dividend yield just to maintain my dividend income.

Now if BAC and Citi were to resume increasing their dividends and I believed that there is a strong fundamental ability in their business models to support such a move, I would gladly buy back as soon as the stocks are not too expensive. If the dividend increases could be supported from the business, then I should be ok in the long run.

I don't consider selling when there is a doubt that a dividend will be cut, because I doubt that anyone can predict what will happen with above average certainty.

Jan 06 01:25 PM

[Chris B:]

1) What will you buy after you sell? Riskier companies? Companies that have not yet announced dividend cuts, but soon will? Companies that are financing their dividends with interest-bearing debt (like GM did for years)? Companies that will be bankrupt in 6 months because they are spending their last cash on dividends to the benefit of insiders? Companies that are mostly interested in pumping up their own stock price in the short term? Yield chasing could be dangerous at a time like this. More responsible companies cut their dividends in severe recessions.

2) Are you giving your money to GE or GS so they can pay Warren Buffet 10% of it and give you back what is left? If a company you own has a choice of borrowing $100M at 8-10% interest to pay a dividend or cutting the dividend, which option would deliver more value to your company? Can you earn 8-10% on your dividend with absolute certainty? Again, GM paid a decade of dividends out of ever-mounting debt. Despite those dividends, shareholders never did get their investment back and never will.

3) Do you have a flip side to this strategy of buying companies you suspect will soon raise their dividend? If not, you'll always be buying and selling after the announcements, resulting in losses of value. Companies won't restore their dividends until the recession is well over. By then you'll be paying double the price for many of them.

4) How can you be sure that the post-dividend-cut underperformance of these companies was caused by the dividend cut and not by... I don't know... the recession perhaps? Massive reductions in earnings? Assets gone sour? Risk of bankruptcy? Which is the cause and which is the effect?

5) What if the company altered its strategy and is using capital for share buy-backs instead of dividends? This would be a smart move right now, with so many solid companies out there priced with single-digit PE's and below book value. Would you sell low when the company is buying out its other owners at 5 year lows? The same argument could be made for companies that are using their capital to buy underpriced business assets such as ships, oil leases, real estate, transport contracts, and competitors instead of sending out a dividend just to pump up their stock price.

Jan 06 02:03 PM

[User 283977:]

This is what I said on Jan 4.

"When BAC was selling at $50 per share it provided an average yield of 4.3%. I consider that as the normal yield for the stock. Holding the current dividend payment constant at .32 cents per share, the stock price required to support a yield of 4.3% would be $29.8. The next ex dividend date is in late February. I doubt BAC is going to double its stock price by then. So I think its more likely they will cut their dividend again in February."

Glitch stated:

"I don't think BofA will cut their dividend any further, at least anytime soon. Cutting a dividend hurts a company's reputation, cutting a dividend twice in less than a year will devastates it. I believe the first cut was made to a level they were confident they could maintain going forward. Any further cut will be due to a lack of available cash, not because the yield is 'too high'."


This is what came out today, January 6.

"SAN FRANCISCO (MarketWatch) -- Bank of America Chief Executive Kenneth Lewis warned that 2008 results will fall short of expectations and said executives at the giant lender, including him, shouldn't get bonuses for last year."

"Based on low tangible capital levels and declining earnings, we believe Bank of America may need to cut its dividend, and/or raise added equity capital," said Stuart Plesser, a financial-services analyst at Standard & Poor's Equity Research.


Summary:
It looks like BAC may have to drop their dividend again, and as Glitch stated, it looks like the primary reason is a lack of available cash. Of course one of the quickest ways of preserving cash is to cut your dividend.

So the call to sell BAC after the last Ex dividend date is looking good. If nothing else, it does appear that the probability of BAC retaining that 8.96% dividend is looking risky.

The CEO is warning and we all know what that usually means for a stock. It appears likely the price will drop when they miss their earnings, and I would not be surprised if the current 8.96% dividend is halved. Doing that should help cushion the stock price after they miss earnings.

Jan 06 07:09 PM

[Dividend Gr...:]

Chris,

1) I focus most of my attention on the Dividend Aristocrats, achievers and champions. I wouldn't say they are more risky than other stocks. I don't chase yield, I am mostly following a balanced yield/dividend growth approach. If the whole stock market falls by 40% in 2009 I would probably lose money as well however. I would never purchase a stock that hasn't had at least an uninterrupted ten years of consecutive dividend increases, although i am mostly interested in stocks that have raised payments for over 25 yrs. Thus i wouldn't have bought GM.

2) I do own GE stock, but after they announced a dividend freeze I am not buying more stock there and buying other stocks with the dividends in receive. I wouldn't buy GS because it doesn't fit my entry criteria.

3) When I posted a bearish article on BAC on seeking alpha in july saying that I don't think dividend is well covered, someone told me how foolish I was to be waiting for the payout ratio to decrease so that the div is well covered. They told me that I would be a buyer when BAC is back over 40. I don't really mind paying a higher price for a stock that could show some resilience in revenues/growth and dividends over time. I don't like cyclical stocks. I do realize that my strategy leads to a higher exposure to consumer names however.

4) Not all companies cut their dividends in this tough environment. In fact most of the dividend aristocrats in 2008 either increased or maintained their payments in 2008. I am looking for rising dividend income. If a company has a strong business model which has enabled it to increase dividends for more than 10 or 25 consecutive years, then chances are it will keep raising them. I do try to be diversified accross sectors and dollar cost average however.

5) Lehman was buying millions in stock in 2008 at an avg price of $40. The price was pretty low. I would much rather have the company send ME the cash than the company deciding it wants to do it for me ( buy back stock). I do like moderation however- XOM does both stock buybacks and dividend increases. Actually most companies "conserving cash" now are the ones which are too leveraged and without cutting their dividends they know they will go belly up. The dividend payment is not their main issue - it is reckless management that used a lot of leverage in order to get big quick and get a larger bonus.


On Jan 06 02:03 PM Chris B wrote:

> 1) What will you buy after you sell? Riskier companies? Companies
> that have not yet announced dividend cuts, but soon will? Companies
> that are financing their dividends with interest-bearing debt (like
> GM did for years)? Companies that will be bankrupt in 6 months because
> they are spending their last cash on dividends to the benefit of
> insiders? Companies that are mostly interested in pumping up their
> own stock price in the short term? Yield chasing could be dangerous
> at a time like this. More responsible companies cut their dividends
> in severe recessions.
>
> 2) Are you giving your money to GE or GS so they can pay Warren Buffet
> 10% of it and give you back what is left? If a company you own has
> a choice of borrowing $100M at 8-10% interest to pay a dividend or
> cutting the dividend, which option would deliver more value to your
> company? Can you earn 8-10% on your dividend with absolute certainty?
> Again, GM paid a decade of dividends out of ever-mounting debt. Despite
> those dividends, shareholders never did get their investment back
> and never will.
>
> 3) Do you have a flip side to this strategy of buying companies you
> suspect will soon raise their dividend? If not, you'll always be
> buying and selling after the announcements, resulting in losses of
> value. Companies won't restore their dividends until the recession
> is well over. By then you'll be paying double the price for many
> of them.
>
> 4) How can you be sure that the post-dividend-cut underperformance
> of these companies was caused by the dividend cut and not by... I
> don't know... the recession perhaps? Massive reductions in earnings?
> Assets gone sour? Risk of bankruptcy? Which is the cause and which
> is the effect?
>
> 5) What if the company altered its strategy and is using capital
> for share buy-backs instead of dividends? This would be a smart move
> right now, with so many solid companies out there priced with single-digit
> PE's and below book value. Would you sell low when the company is
> buying out its other owners at 5 year lows? The same argument could
> be made for companies that are using their capital to buy underpriced
> business assets such as ships, oil leases, real estate, transport
> contracts, and competitors instead of sending out a dividend just
> to pump up their stock price.
>

Jan 06 10:09 PM