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When creating and managing a portfolio I feel it is important to set rules for buying and selling, and stick to those rules, no matter what. You can adjust the rules over time, but don't let the emotions of the moment cause you to go against the rules you have set up. I also feel it is important to keep the rules fairly simple, so that you don't have any problems following them. I think this helps keep emotion out of your investing decisions. Investing decisions based on emotion are one of the biggest factors hurting over all return. As a dividend growth investor, since collecting an ever increasing stream of dividends is my main goal, I have decided that the only criteria I have for selling a stock is if it cuts its dividend. Price changes (up or down), earnings misses, economic issues… none of these will make me sell. Since my buying criteria are designed to pick quality stocks with an excellent history of dividend growth, once a stock has met my criteria to be purchased the only thing that will make me sell it is if it cuts its dividend. Many others who use the DGI philosophy also use this as one of their main selling criteria, although not always the only criteria.

But some have criticized the idea of waiting for the actual dividend cut announcement, because they say that by that time the stock most likely has already fallen significantly and the damage is done. They think you must look for the signs of an impending dividend cut, and sell before it happens. I argue that even with signs of a possible dividend cut the cut doesn't always happen, and by continuing to use dividend reinvestment you may be buying more of the stock in question at a great value. I also would argue that even if a stock does cut its dividend, and you sell it at a loss, as long as that stock was part of a well diversified dividend growth portfolio, the damage to your portfolio over the long term would be minor. I set out to demonstrate this.

To study the damage dividend cuts can do to a portfolio, I picked one of the worst periods of time for dividend stocks, the "Great Recession" of 2008-2009. To do this study I used David Fish's CCC lists, going back to one of the first ones he ever produced -- the list from 1/15/2008. The archives for David's CCC lists can be found HERE. This archive is maintained by Robert Allen Schwartz. By using a list that was created in real time, back in January of 2008, right before the market crashed, I could do the study while removing the problem of survivorship bias. I used the criteria I use for buying in my K.I.S.S. (Keep It Simple Stupid) portfolio to create a portfolio from the CCC list, and then followed the portfolio up to present day, reinvesting all dividends back into the stocks that paid them, and only selling a stock if it cut its dividend. On January 1st of each year I would use the proceeds from stock sales to buy new stocks that met my criteria, as long as I had $10,000 (the amount I used to initiate all positions) to put into the new position.

Since the CCC list back in 2008 did not have as much information as they do now I had to modify my criteria slightly from what I presently use. The buying criteria I used for this study were as follows…

  1. The stock was a dividend champion as of Jan 15th, 2008
  2. Dividend yield was 2% or greater
  3. The stock's yield plus dividend growth had to be 12% or greater. This is the Chowder rule, but I had to use the one year DGR, rather than the 5 year that Chowder uses, because only the one year growth rate was listed.
  4. Payout ratio and S&P quality ratings were not used, as they usually are for my K.I.S.S. portfolio, because they were not available to me.
  5. When new purchases were made later in the study period, using money from sales of stock, the Chowder number was used as a tie breaker if I did not have enough money to buy all the stocks that met my criteria.

The following stocks met the criteria in January of 2008 and were put into the initial portfolio:

  • Abbot Labs (NYSE:ABT)
  • Advanced data processing (NASDAQ:ADP)
  • Associated Banc-Corp (NASDAQ:ASBC)
  • Bank of America (NYSE:BAC)
  • BB&T Corp. (NYSE:BBT)
  • Bemis Company (NYSE:BMS)
  • Anheuser Busch (NYSE:BUD)
  • The Chubb Corporation (NYSE:CB)
  • Clorox (NYSE:CLX)
  • Comerica Inc. (NYSE:CMA)
  • Diebold Inc. (NYSE:DBD)
  • Emerson Electronics (NYSE:EMR)
  • First Dollar Corp. (NYSE:FDO)
  • First Third BanCorp. (NASDAQ:FITB)
  • Gannett Co, Inc. (NYSE:GCI)
  • General Electric (NYSE:GE)
  • Hershey (NYSE:HSY)
  • Illinois Tools Works (NYSE:ITW)
  • Johnson and Johnson (NYSE:JNJ)
  • Leggett and Platt (NYSE:LEG)
  • Eli Lilly (NYSE:LLY)
  • La-Z-Boy (NYSE:LZB)
  • McDonald's (NYSE:MCD)
  • Marsh and Ilsley (NYSE:MI)
  • M&T Bancorp (NYSE:MTB)
  • PepsiCo (NYSE:PEP)
  • Pfizer (NYSE:PFE)
  • Procter & Gamble (NYSE:PG)
  • Pentair Ltd. (NYSE:PNR)
  • Regions Financial Corp. (NYSE:RF)
  • Rohm and Haas (ROH)
  • RPM International (NYSE:RPM)
  • Sherwin Williams (NYSE:SHW)
  • Sysco Corp. (NYSE:SYY)
  • UDR Inc. (NYSE:UDR)

Historical quotes were taken from Yahoo Finance. $10,000 was put into each position, to the nearest whole share, so a total of $349,262.89 was invested. From 1/15/08 through 5/16/13 all dividends were reinvested back into the stock that paid them. If a dividend cut was announced, that stock was sold on the ex-div date of the new, lower dividend.

Due to the sale of stocks that cut their dividend (and buyouts), and reinvestment of this money into new positions, In January of 2009 the following three new stocks were purchased.

  • Dover Corp. (NYSE:DOV)
  • Johnson Controls (NYSE:JCI)
  • Medtronics (NYSE:MDT)

In January of 2010, again, due to stock sales (and buyouts) a further four new stocks were bought.

  • Aflac (NYSE:AFL)
  • Colgate Palmolive (NYSE:CL)
  • Hormel (NYSE:HRL)
  • Wal-Mart (NYSE:WMT)

The following table shows all the stocks that were bought during the study period, the number of shares bought, the final number of shares held (due to reinvestment), and the final value either on 5/16/13 or when the stock was sold. Special situations are marked by asterisks and explained below.

INITAIL

FINAL

DATE SOLD

STOCK

PRICE

SHARES

PRICE

SHARES

VALUE

ABT*

$59.43

168

$36.83

182.42

$6,718.67

ABBV*

$34.39

180.97933

$46.21

184.82

$8,540.43

ADP

$39.55

252

$70.98

295.78

$20,994.48

AFL

$49.41

250

$55.24

273.00

$16,468.20

ASBC

$22.60

442

$19.00

477.90

$9,080.18

5/4/09

BAC

$35.97

278

$15.24

300.70

$4,582.61

12/1/08

BBT

$29.42

339

$20.63

374.49

$7,725.73

7/6/09

BMS

$24.01

416

$40.65

493.46

$20,059.30

BUD**

$52.34

191

$70.00

191.00

$13,370.00

11/18/08

CB

$48.02

208

$89.87

238.42

$21,426.40

CL

$81.51

152

$124.08

165.88

$22,342.20

CLX

$60.75

164

$87.57

196.74

$17,228.82

CMA

$36.64

272

$19.21

293.52

$5,638.59

12/8/08

DBD

$24.49

408

$30.40

496.78

$15,102.11

DOV

$33.15

301

$77.21

333.02

$25,712.34

EMR

$49.19

203

$58.03

239.33

$13,888.17

FDO

$17.69

565

$64.46

616.07

$39,712.18

FITB

$22.60

442

$10.23

457.96

$4,684.92

6/23/08

GCI

$34.03

293

$2.20

330.49

$727.07

3/2/09

GE

$34.31

291

$12.10

319.04

$3,860.43

6/15/09

HRL

$19.05

651

$42.70

696.70

$32,353.19

HSY

$36.74

272

$89.94

314.92

$28,324.25

ITW

$47.15

212

$69.91

245.54

$17,165.55

JCI

$19.10

523

$37.54

575.85

$21,617.51

JNJ

$66.29

150

$87.45

178.80

$15,636.02

LEG

$16.14

619

$33.73

814.07

$27,458.51

LLY

$53.71

186

$55.94

244.38

$13,670.41

LZB

$6.39

1,564

$3.15

1599.93

$5,039.78

11/17/08

MCD

$52.40

190

$101.12

223.99

$22,650.36

MDT

$32.61

306

$49.17

338.94

$16,665.46

MI

$26.48

377

$13.64

409.17

$5,581.09

12/08

MTB

$73.69

135

$104.69

165.11

$17,285.11

PEP

$71.46

139

$83.74

162.56

$13,612.65

PFE

$22.50

444

$14.40

489.46

$7,048.20

5/4/09

PG

$67.15

148

$80.20

173.90

$13,946.58

PNR

$27.78

359

$57.53

406.07

$23,361.42

RF

$19.19

521

$11.69

550.64

$6,436.92

9/8/08

ROH***

$53.07

188

$78.97

188.00

$14,846.36

4/1/09

RPM

$20.11

497

$33.39

614.70

$20,524.95

SHW

$53.25

187

$189.98

208.33

$39,578.07

SYY

$27.96

357

$34.89

430.80

$15,030.61

UDR

$20.27

493

$9.77

579.34

$5,660.14

4/6/09

WMT

$53.33

232

$77.87

252.95

$21,480.46

FinalValue

$588,555.03

* Abbott spun off Abbvie (NYSE:ABBV) in January of 2013. The value of both ABBV, which remained in the portfolio and continued to pay dividends, and ABT is included.

** Anheuser Busch was bought out by AmBev in November of 2008 for $70 per share. $189 in dividends was collected prior to the buyout and is included in the final value. This money was not reinvested since I was unable to find price information.

*** Rohm and Haas (ROH) was bought out by Dow Chemical (NYSE:DOW) in April of 2009. $376 in dividends was collected prior to the buyout and is included in the final value. This money was not reinvested.

The DATE SOLD column shows the ex-div date the stock was sold if it cut its dividend. Otherwise the stock was held until 5/16/13.

There was over $54,000 to invest at the beginning of 2010 due to stock sales and buy outs during 2009, but only 4 new stocks met the criteria for purchase. I would not have wanted $14,000 sitting in my account for a year, not producing income, so $13,500 was put into each of these four stocks, rather than the usual $10,000.

The final value of $588,555.03 shown at the bottom of the table does not include the end value of stocks that were sold due to a dividend cut, merger, or buyout (even though this value appears in the column). Any stock that has a DATE SOLD next to it was not included in the final portfolio value because that money was used to buy new positions.

SUMMARY 12 of the 35 stocks (34.3%) cut their dividend during the period of the study and were sold. This is a much higher rate than usual, and shows what a toll the recession took on stocks, even dividend paying ones. And yet even with taking a loss on each of these stocks the portfolio still turned $349,262.89 into $588,555.03, a yearly return of 10.27%. This is compared to the S&P, which returned 4.20% over the same time period.

The dividend income was hit hard, dropping by 34.2% in 2009. This drop is to be expected since 7 stocks with relatively high yields were replaced by 3 stocks with lower yields. But over the next 5 years it recovered. By 2013 it was higher than it had been in 2008.

Dividend income year by year was as follows:

2008$13,141.61
2009$8,645.57
2010$9,797.53
2011$10,868.60
2012$12,184.90
2013$13,432.50

Every stock that continued to raise its dividend throughout the study period showed a positive return, once again showing how powerful dividend growth investing can be, even through the worst time periods.

CONCLUSION

Many dividend growth investors focus on their dividend income, and by that standard they may be concerned by these results since the income dropped significantly from 2008 to 2009. But in 2010 it grew by 13.3%, and by 2013 it was higher than it was in 2008. So the income recovered fairly quickly from the dividend cuts. Would it be possible to protect your income better by selling stocks before they cut their dividend? Perhaps. But I don't believe I'm smart enough to determine whether or not a company will cut its dividend. Neither I, nor anybody else, can predict the future. I'm much more comfortable acting only when a dividend cut actually happens.

The Great Recession was very hard on stocks and companies. And yet 22 out of 35 of the stocks in this study continued to raise their dividend during the time period. (One stock, MTB, held its dividend steady throughout the study period, and another, LLY, only raised its dividend once, but never cut it). This tells me that if you select your companies carefully, and pick the best dividend growth stocks, even during the worst of times, your portfolio will do well. As long as you monitor your stocks for dividend cuts, and sell as soon as one happens, then a buy and hold philosophy can work.

Many dividend growth investors here on SA say they don't invest in financial stocks due to the lack of clarity in their financial statements. Most of the stocks that cut their dividend were financial stocks, so these investors would have been protected from much of the loss in dividend income.

The PE ratio and the company's earnings history were not included in my buying criteria. And yet the portfolio did very well. I don't think I would go so far as to say looking at the dividend history is all you need to do, and that the earnings can be ignored, but it is interesting to note.

Finally, if, in 2008 you had told me that a paint manufacturer, and the maker of "Spam" would be two of the best performing stocks over the next few years I would have questioned your sanity. And yet Hormel and Sherwin Williams were outstanding performers over the past 3-5 years. Just goes to show you that you never know. But if you set your criteria well, diversify well, and pick stocks with an excellent dividend history, you will pick stocks that will give you excellent performance, even during bad recessions, and your portfolio will do very well, even if you don't try to predict dividend cuts.

Thank you for reading my article. I welcome your comments.

Source: It's Okay To Wait For A Dividend Cut Before Selling