In the comment thread of my last article a very interesting stream of opinions evolved around selling or holding positions which have had a reasonable run up. The question emerged whether to keep cash cows in a DGI portfolio or (partly) close a position of stocks which are now worth considerably more than what we bought them for. Particularly mentioned were Aflac (NYSE:AFL), Walgreen (WAG), Lockheed-Martin (NYSE:LMT) and Medtronic (NYSE:MDT). I currently own shares of three of these fine dividend cash machines in our Roth IRAs and am on the way to re-buy into Walgreen after selling my stake last year.
I was young and dumb and so I sold my Walgreen shares to take a 33% profit off the table. I thought this money would be better off in another stock which had a higher entry yield than those lousy 2.x% I got from the drugstore. Today I'm older (and maybe a little wiser) so I argued that I wouldn't sell my ownership of such high achievers. What I want to attain over the next 20-something years is a safe income stream for our retirement which outperforms inflation by a wide margin and easily supports our humble lifestyle without having to rely on social security pensions. So the question remains, should I sell or should I hold on to the insurance, the military contractor and the medical devices manufacturer. The stock I would consider replacing them for is Walgreen, currently the #2 on my screening list.
Case #1: Aflac
I bought AFL in May 2012 for $43.25. This stock trades @ $66.13 at the time of this writing which is a 52.9% increase. For the sake of easy math I'll ignore commissions and taxes here, especially since there are no tax implications within my Roth account. I have collected seven dividend payments from Aflac so far, with the last payment from earlier this month bringing my annualized yield to ~3.4% of the original cash outlay (yield on cost). According to the BLS, the inflation rate for the trailing twelve months is 1.0%, so my yield beats that by 2.4%. The dividend growth rate for one year stands @ 8.9%.
I currently don't reinvest my Aflac dividends back into the company due to the run up in price which brought the yield down and because some of my screening metrics have changed. So what would happen if I sold my stake in Aflac right now and put the money in Walgreen instead? WAG has a current entry yield of 2.2% and a growth rate of 24.9%. It would take me a little over three full years of dividends to break even when I take one sell and one buy commission into account. So in the fourth year I'd start to see an advantage of closing Aflac now and putting that money to my best current prospect. It may actually be a good idea to consider a swap here but I'm not convinced yet.
Case #2: Lockheed-Martin
My LMT position was opened in January 2013 @ $89.35 and I added some more shares in March @ $93.08. My cost basis without dividends stands @ $90.95. Today's closing price for the stock is $139.03 which is a gain of 52.9% no commissions included. As of today I have received three dividend checks into my account but in order to make it an even number I'll include the fourth declared dividend for this year, which will be paid on December 27. This next payment will increase the annual yield to quite exactly 5% of what I paid for the ownership rights. A whopping 4% after taking inflation into account (the next BLS price index change will be announced on Tuesday 12/17). The last dividend increase was an impressive 16%.
Lockheed-Martin is a very special case in my dividend portfolio. It has a high yield and a high growth. Although I'm not considering any more buying of the stock right now, I got my shares for a very good price and therefore enjoy a very good return on my investment. Due to the price increase over the last months many dividend stocks have seen their entry yields under pressure. They're still good ownership prospects but if I sold my LMT position to put the money into one of those current low yielders in the 2-3% ballpark, I'd lose money.
Case #3: Medtronic
MDT became a part of my retirement savings in July 2012 when somebody must have thought it was a good time to sell and gave me his shares for $38.18 apiece. Today's closing bell locked in a price of $55.89, a 46.4% increase over what I paid for it. Five dividend checks have been deposited to my broker's account. The management was kind enough to speed up the payment of the typical January dividend into December of 2012 due to the fiscal cliff discussion looming over us a year ago. The company's last payment equaled an annualized 2.9% of my investment. Considering the statistical 1% price increase over the last twelve months leaves me with a meager 1.9% margin. Not very compelling. Dividend growth for the one year period is 8%, coming down from 16% annualized average over the last five years.
For the same reasons as with Aflac, I have discontinued to plow Medtronic dividends back into the company they come from. Exchanging this holding with Walgreen again would take me almost five years to break even when working in two commissions for the deal.
Of course with higher dividend growth the drawback of the lower initial yield will diminish after a few years. Two of the three cases I talked about today would take somewhere between three and five years until the higher growth stock would overtake the higher initial yielder with the lower growth. A couple of years is nothing when you have a 20+ years time horizons to grow your income stream, especially when the growth outpaces everything easily after those initial drier years. Since the growth outlook is highly hypothetical and solely based on past performance, it still might be a better idea to prefer the bird in the hand over two in the bush.
I am certain at this point in time that my LMT position will not be touched in order to take a profit. However, I can no longer ignore the possibility of replacing AFL and/or MDT with a fresh dividend growth stock. I will not take any action right now but will have to see where both stocks are heading during the next couple of weeks and months. The long term goal is way too important to ignore developments along the way. Most investors consider a sudden price hike of their stocks a good thing but I've always said I don't like prices going up too quickly and this essay reassures me of that opinion.
Disclosure: I am long AFL, LMT, MDT. 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.
Additional disclosure: I may initiate a long position in WAG over the next 72 hours.