It's tough going for value investors at the moment. With the Dow Jones Index continually zipping along and hitting new highs daily, a number of dividend stocks are starting to trade in ranges where the current yield on offer is less than their historical yield.
While I don't believe we are necessarily in a bubble, it's getting superficially more tempting to sell out some stocks and replace them with other dividend stocks that haven't enjoyed the ride up and are still offering substantial yields.
High Quality dividend stocks such as Johnson & Johnson (NYSE:JNJ), Pepsi (NYSE:PEP) and Coca Cola (NYSE:KO) are offering a lower dividend yield and trading at higher price to earnings multiple than what they have on average over the last 5 years.
Coca Cola is offering a dividend yield of around 2.4%, compared to a 5 year average dividend yield of slightly under 3%. Pepsi is offering a yield of 2.6% compared to an average 5 year yield of close to 3%. Johnson & Johnson is offering a yield of 2.8% versus a historic 5 year average yield of 3.3%.
In spite of quality dividend growth stocks trading at premiums to historical averages and offering lower yields, I am not planning on selling any of the stocks in my dividend portfolio for a variety of reasons.
Lack of quality replacement businesses
Companies with long histories of growing earnings and increasing dividends are in short supply. The earnings, and therefore dividend, quality of Coca Cola or McDonald's (NYSE:MCD) (which I own) is tough to replicate.
Both are businesses that have been paying and increasing dividends for more than 50 years. These dividends have survived through poor economic periods and a variety of stock market collapses. While there are other companies in the market today that may be offering higher current yields or haven't benefited from the market rally, many do not have the long term dividend history of either Coca Cola or McDonald's.
The challenge for an investor is to not dilute the quality of their dividend businesses by substituting a high quality earning and dividend stream with an inferior one as a result of brief periods of full valuation.
Tough to buy back in
Selling out today with the intention of buying back in later when things get cheaper is a great idea in theory, but tougher to execute in practice. First, quality companies very rarely sell at substantial discounts apart from major stock specific events or general panic as we saw during the recession of 2008-2009.
In fact, even during the recession of 2008-2009, Coca Cola and McDonald's weren't so significantly marked down as to present compelling bargains. Coca Cola traded on a dividend yield of 3.36% at the end of 2008 while McDonald's got to a dividend yield of around 3.3% during this period.
More to the point, I don't want to experience sellers remorse again, which my prior sales of McDonald's and Coca Cola continue to cause me to this day.
I had the good foresight of steadily accumulating Coca Cola between October 2008 and April 2009. Unfortunately my judgment wasn't so good when I offloaded it all in May 2010.
While I was able to book a nice profit on the sale with Coca Cola, I have been struggling to find a reentry price that I think is compelling value to buy back in since then. Funnily enough, the same story repeated itself with my purchase of McDonald's during the 2008-2009, though in that instance, I couldn't contain my impatience and bought back at a higher price than I probably should have.
Getting into a cycle of continually comparing current yields on offer with either historic yields for a stock or current yields for other stocks can get an investor into the dangerous habit of yield chasing. When current yields are low, there can be a temptation to redeploy capital in search of something better.
Such behavior isn't really consistent with being a partner in a business. Investing during strong markets tests ones patience as much as weak markets where there can be restlessness to take some action and not let an investment in time do its work.
While in weak markets there can be a restlessness to minimize losses, in strong markets there can be a temptation to seek value and go after higher yield.
Investment Thesis unchanged
My main criterion for selling a dividend paying stock is if the dividend happens to get cut or if there is a deterioration in the underlying earnings stream of a business. Market revaluation of a business and income stream by a market either upward or downward has never historically been a motivation to sell.
I've largely held this view because market valuation changes minute to minute or month to month. I've set myself a goal of not buying and selling high quality businesses weekly or monthly because they are going out of style or because they are in high demand.
Businesses with high quality earnings streams can be difficult to source at a reasonable price. Selling out these businesses too early can lead to a missed opportunity for substantial income and capital growth over the longer term, particularly in situations where there may only be mild, if any overvaluation.
High quality businesses like McDonald's and Coca Cola are currently in a sweet spot for earnings and dividend growth. Earnings for both businesses have been growing consistently in recent times. In my view, there are currently no obvious reasons to suggest that this track record won't continue into the future.
Selling high quality dividend stocks during a bull run in the market could be to the long term detriment of a dividend portfolio and the maintenance of a high quality, rising income stream. In my view, businesses that consistently increase dividends create substantial wealth over time, and selling too early can seriously short change an investor out of significant returns.