I'm retired with my retirement income supported by a portfolio of stocks that are Dividend Champions, Challengers and Contenders. Even though I'm a Dividend Growth investor for the past few weeks while the market reached for new highs I've been struck with this troubling feeling: Don't just stand there Bob, you need to do something. The problem, if there even is one is this: Exactly what is it I should be doing?
Clearly I'm not alone in this feeling as evidenced by a recent message I received from one of my readers:
I feel the need to take profits in a market like this, but I can't get my mind around how to do it or if I even should!
I am retired and have been gradually buying dividend growth stocks and just now reached a point where I can live from my SS and my Dividends. I still have more cash to invest but at the same time I feel like I want to capture gains as well before they disappear.
Recently I sold off stocks yielding less than 2.5% and redeployed 1/2 of that money into higher yielding stocks and still increased my income. I am putting the other 1/2 aside for something special or possibly as living expenses. Today I sold just enough shares of my McDonald's (NYSE:MCD) to equal the gain and to bring it back under 4% of my portfolio. What are the proper guidelines or methods to take profits in a dividend growth portfolio? Should I even be doing this at all? Any help or links to articles on this subject to make it more clear would be appreciated.
My response to my follower included:
We share much in common as I have also been stuck with the feeling that I need to do something. Like you I find the problem is deciding on just what. I'm not sure if there is a pull back what I would buy. I favor low beta stocks and very few are under valued these days. Low Beta stocks are also more likely to maintain their value when a pullback does finally come. It's always prudent to be prepared for possible buying opportunities. I try to keep a watch list of about twenty stocks I might consider for purchase.
I love your idea of rewarding yourself for all your hard work and due diligence by setting something aside for a special trip or a special purchase.
After my early morning response to my reader, I took another sip of coffee and followed that with a deep breath. Seriously,what should I be doing? I started by reviewing the advice I'd just given. In my sector allocations I'm a little light in utilities. Now may be a good time to add.
Next I looked at my higher beta holdings: Leggett and Platt (NYSE:LEG), B&G Foods (NYSE:BGS), and Paychex (NASDAQ:PAYX) would be the leading candidates for "taking profits". Since two other high beta holdings Conoco Phillips (NYSE:COP) and Royal Dutch Shell (NYSE:RDS.B) are currently undervalued it is not likely I will reduce either.
Before doing anything more, I decided to step back and look at all my alternatives moving forward. Strategies that I could adopt include:
Do nothing - If it ain't broke don't fix it!
Take profits - redeploy into higher yield.
Many suggest that in overheated markets it's wise to ..."take a little off the top". This refers to a stock that has had a healthy capital gain. The concept being that no one ever lost money by taking a profit. As a retiree with a Dividend Growth portfolio providing a monthly income stream the rules change a bit. My goal is to maintain retirement income from dividends that are steady, providing the same amount of income or more each month. Ideally funds obtained from taking profits would then be redeployed into a stock with greater yield and similar dividend growth.
Look at portfolio beta and if necessary make adjustments
As part of my portfolio plan I seek to maintain an overall portfolio beta of under 0.7. Taking profits on my higher beta holdings might prove a prudent move.
Look at sector representation and consider adjustments
If you believe a pullback is on the way it's probably not the best time to load up on additional financial or tech offerings. I just researched the performance of each of my 52 holdings and the 20 on my watch list looking specifically at the last 3 month and 1 month periods. I was somewhat surprised at just how strong my utilities had been for those periods particularly since they had earlier been under performers. Utilities traditionally do very well during pull backs so if you're underweight in that sector you might want to research that area. If you're holding a lot of cash you might even consider putting it in XLU - an utility ETF and then sell off shares and redeploy when buying opportunities present themselves.
Since I'm currently under represented in utilities I might look there were I to open a new position or add to my existing ones.
Sell and redeploy lower yield holdings
I usually don't consider a stock that doesn't pay a dividend of 3.5% at the time of purchase. Were a stock after a run up now to yield only 2.2%, I could consider selling and buying a sound and stable stock on my watch list with a higher yield and similar dividend growth.
Those are the options I came up with. Before you decide what action is best for you let me offer a few more recommendations:
Look at a year by year performance history for each stock in your portfolio
It helps my decision making to look at each stock's performance year by year. I look at performance during severe bear markets, preferring stocks that perform the strongest in the worst of times. I also like those that a history of coming back quickly after a loss.
I started my own stock picking in 2011, certainly a year not for the faint of heart. I looked at the period 2002 - 2011. This period has it all, huge declines in 02 and 08 plus whatever you call 2011. Any stock that performed well against the market in 02, 08 and 11 with a yield of around 3% or more and decent 5yr Dividend Growth Rate got my attention and deserves yours now.
I recommend that if you don't have year by year performance histories on each of your stocks that you spend some quality time doing research at the Morningstar website. Just place a stock ticker in the box. Next Under stock name, click on the "performance" tab located on the second bar. Under last price, click on expanded view. You now have a year by year performance history from 2003 to 2012. Look at each stock's performance in light of your personal risk tolerance. I like stocks that had no more than three down years and ones that significantly out perform during bear markets.
Look at stock value. You don't want to over pay.
Use Morningstar or Fast Graphs to help determine those stocks that are fairly or undervalued.
Take the time to create a portfolio business plan.
Having a business plan in place for my portfolio helps insure I buy and sell my holdings for the right reasons.
After considering my options, I chose to do nothing and simply continue to stick with my business plan. Since I am fully invested and bought great stocks that were fairly or undervalued they have produced good dividend growth. In a strong market loss of income due to dividend cuts is reduced. Hopefully dividend growth will also flourish in this environment. I must say I feel so much better after carefully considering my options. Now it's your turn. in the comment section below tell us what do you do when the market gives you "that funny feeling" that you need to do something.
Disclosure: I am long MCD, LEG, BGS, PAYX, COP, RDS.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.