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Long term dividend growth investors have a reputation for being stubbornly resistant to selling stock. Even in the face of negative noise surrounding the companies in which they've invested, disciplined dividend growth investors will usually stand firm, resolute in their conviction that short-term noise seldom provides a good basis for a sell decision.

One development that will cause many dividend growth investors to immediately consider selling a stock, however, is if a company fails to raise its dividend annually. With some, selling in this instance is not something merely to consider but instead it must be done. The proceeds of the sale can then be used to purchase a stock whose dividend is in fact growing.

As a dividend growth investor myself, I understand that creating a growing stream of dividend income is the ultimate goal and purpose of this approach to investing. Even so, I am often surprised by the strength of dividend growth investors' aversion to even the slimmest possibility of a dividend freeze. While sustained dividend growth is the goal, why does a momentary hiccup in the steady march upwards necessarily mean that one must immediately sell a carefully chosen dividend growth stock?

In this article, I argue that dividend growth investors should not automatically sell in the wake of a dividend freeze and that the occasional dividend freeze can actually further our goals as dividend growth investors.

A Dividend Freeze Need Not Result in a Loss of Income or Halt A Portfolio's Dividend Growth

Before examining how the occasional dividend freeze can actually help dividend growth investors, it is worth noting that a dividend freeze does not result in a loss of income but merely a cessation of a part of the growth of that income. This may seem like an obvious point, but the extreme aversion of many dividend growth investors to dividend freezes suggests that this point is often forgotten.

Consider too that just because one company freezes its dividend does not mean that the dividend growth of one's entire portfolio is halted. To illustrate this point, let's assume that an investor has a portfolio consisting of 20 equally weighted positions that each boast an annual dividend growth rate of 5%. The total dividend growth rate of the portfolio is 5% ((20 x .05)/20). Now, let's say that one of the companies freezes its dividend. The total dividend growth rate of the portfolio in this case is still a very respectable 4.75% ((19 x .05)/20)! If one increases the number of positions in the portfolio, then the effect of a single dividend freeze is even smaller.

These facts alone are enough to convince me that a dividend freeze is not the immediate threat to dividend growth that many investors treat it as.

A Dividend Freeze May Be Directly Correlated with an Increase in the Purchasing Power of Reinvested Dividends

It goes without saying that dividend freezes often occur when companies are in some sort of trouble, and the stock price of those companies often reflects this fact. Furthermore, selling by dividend growth investors who balk at riding out a dividend freeze can exert additional downward pressure on the price of affected stocks.

Another way of saying this is that the existence of a dividend freeze at any given point in time is likely to be correlated with relatively lower stock prices than might otherwise be the case. This means that those who reinvest dividends and who are willing to ride out the frozen dividend may be able to purchase more shares than they otherwise would have for as long as the freeze is in place.

Dividend Freezes Seem to Only Rarely Lead to Dividend Cuts

Some will argue that the reason to sell a stock in the wake of a dividend freeze is that a freeze may portend more trouble ahead, including the possibility of a dividend cut. This line of thinking makes intuitive sense, but is it borne out by the facts?

To answer this question, I looked at the latest edition of David Fish's Dividend Champions list, an indispensable document that lists companies that have raised their dividends for at least 5 years in a row. An appendix labeled "Deletions" lists roughly 104 companies that were deleted because they froze their dividend. I say that there are roughly 104 because there were a few companies that I didn't include because they were acquired shortly after freezing their dividend, didn't have a streak of 5 years prior to the freeze, or I just couldn't understand their dividend history (e.g., KRFT).

What I found was that of the 104 companies that were deleted because of a dividend freeze, their subsequent dividend history was as follows:

  • 55 (52.9%) had subsequently increased their dividend.
  • 42 (40.4%) still had a frozen dividend.
  • 07 (6.7%) ended up cutting their dividend.

To be sure, this data has its limitations. For starters, the Dividend Champions list hasn't been around for that long and so it's always possible that some of the companies with frozen dividends might have ended up cutting their dividends given a longer time frame. Additionally, the companies on the Dividend Champions list tend to be very high quality companies that may not be representative of the entire universe of companies in which one can potentially invest.

Still, even with these caveats in mind, it is hard to ignore the fact that in more than 90% of cases, a dividend freeze did not lead to a subsequent dividend cut.

Conclusion

A dividend freeze is some evidence of troubles that may warrant selling a dividend growth stock. But a dividend freeze, standing alone, does not necessarily mean that a dividend cut is imminent or that a company is doomed. In fact, it may spell the beginning of a period in which reinvested dividends will get more bang for their buck. As such, dividend growth investors should refrain from automatically selling a dividend growth stock in the wake of a dividend freeze and should instead examine each affected stock on a case by case basis. If the initial investment thesis still holds, then the dividend cut would seem to be an insufficient basis for a decision to sell.

Source: The Case Against Selling In The Wake Of A Dividend Freeze