The intent for all of my dividend growth stock purchases is to hold them forever. My first purchases included Wal-Mart (NYSE:WMT), Coca-Cola (NYSE:KO), AT&T (NYSE:T), and McDonald's (NYSE:MCD). These are companies that I believe are set up for success in the long term and will continue to share their profits with shareholders. From anecdotal evidence, it appears most dividend growth investors have these companies in their stable of holdings. I would like to believe that I will never have to sell any of these holdings, but as history has shown, there will come a time and place where it may be prudent to sell. As a dividend growth investor, my goal is to anticipate and sell a holding prior to a dividend cut.
Buy and monitor
The term "buy and monitor" has been substituted for "buy and hold" amongst the dividend growth investing crowd. The monitor part of buy and monitor is where discipline and hard decisions are required. The key items that I monitor for each company that I own are listed below:
- Dividend: Is it growing year over year?
- Revenue: Has it grown from the previous year?
- Gross Margin %: Is it stable or growing?
- Operating Margin %: Is it stable or growing?
- EPS: Is it growing?
- Share Count: Is it stable or declining?
- Book Value: Is it growing?
- Operating Cash Flow: Is it flat or growing?
- Free Cash Flow: Is it stable or growing?
- Valuation: Is the current P/E lower than the 5 year average?
When I developed my strategy for monitoring my holdings I wanted to make it a repeatable process that serves to highlight potential problem areas for me. Each item listed above has a "yes" or "no" answer to it. For each company that I own, I review each metric listed above during the first month of every quarter. I use the trailing twelve months in comparison to the previous year. I will use McDonald's in Q2 2012 for my example below:
McDonald's Corporation Example
McDonald's appears to be firing on all cylinders, and they have scored a perfect score on the metric evaluation. I do not consider each metric to have the same value, therefore I apply the following weightings to each metric highlighted above:
In a spreadsheet I keep records for each company that I analyze and for each quarter. For the 4 companies that I listed above, the weighted results for Q2 '12 are as follows:
The final step in the evaluation process is knowing when to sell. The selling rule that I have put in place is:
When a company has had below 65% on the weighted calculation for 6 straight quarters, I sell.
I feel that after 6 quarters of below 65% a company is at a high risk for a dividend cut. I currently have not had a scenario where I needed to sell. I also have not had a dividend cut for any of my holdings. If I were to miss a dividend cut when following this process, then I will evaluate where the process failed and make adjustments. As shown above, even companies that I consider exceptional do fall below the 65% threshold at some points. A single quarter below the 65% threshold is not alarming but when a company begins to string together consecutive quarters below 65% I start to take notice.
Putting together a methodology to monitor your holdings is critical to a successful investing career. The goal of this standardized process is to help investors from falling in love with certain holdings. Even our favorite holdings will have to potentially be sold at a point in time, and we need to make certain that we are accurately evaluating these scenarios.