I am not a stock trader; I am a dividend and value based long-term buy-and-hold investor. When I add a stock to my dividend portfolio, it is my intention to hold the stock forever. I am not smart enough to time the daily gyrations of the stock market. When stock prices start dropping, our primal instinct of flight kicks in and we want to sell. In many cases that is the time to be buying. However, sometimes selling a stock is the right thing to do.
In determining when to sell a dividend stock, I have one hard and fast rule: When an individual stock held as a dividend investment lowers its dividend, immediately sell it. This may seem like a stringent rule and I have taken a lot of criticism for it from both directions.
Some have said waiting until a stock drops its dividend is too late. There were rumors and innuendos that Bank of America was going to drop its dividend some time before it was announced. As it turns out, the rumors were correct this time. However, I can't (and won't) base investment decisions on innuendo or rumor.
Others have said that selling a stock after it cuts its dividend is too early. Their argument is the bad news has already been priced into the stock and you are selling into weakness. I feel strongly that an immediate sell is the correct thing to do for the following reasons:
I. Cockroach Theory
When a company that has a long history of raising dividends and suddenly stops, it is usually more than a simple bump in the road. For the one cockroach you have seen (lower dividend) there are probably hundreds waiting to reveal themselves.
II. Adultery Theory
I view a dividend cut as financial infidelity by the company. After a company has raised its dividend 10, 20, 30 or more years that first dividend cut is very hard. Like someone who first has a series of affairs after 30 years of marriage, the first one is guilt ridden, but it is much easier the second time around. Eventually, the guilt goes away. Do you think Citigroup (NYSE:C) would have the same difficulty cutting its dividend again? In the case of C, I sold part of my position when it became evident that its capital structure could not sustain the company going forward without a substantial cash infusion.
My experience has been once a company cuts its dividend, the stock continues to drop. The following stocks, which I sold after a dividend cut (prices as of 10/13/08) are examples of this:
- Washington Mutual Inc. (NYSE:WM) - Sold at $18.11 on 12/11/2007; it's now worthless.
- Wachovia Corporation (NASDAQ:WB) - Sold at $25.89 on 4/15/2008; it's now trading at $5.85.
- iStar Financial Inc. (SFI) - Sold at $2.32 on 10/3/2008; it's now trading at $1.46.
- Bank of America Corporation (NYSE:BAC) - Sold at $28.51 on 10/7/2008; it's now trading at $22.79.
Sure BAC will likely come back over time, but WM and WB will never come back. Even assuming BAC will come back at some point in the future, I likely would have been better to sell, wait for the 30-day wash sale window to clear and buy it back (see IV below on why this is not an option for me.)
IV. Portfolio Goals
The most important reason for selling a dividend stock after it cuts its dividend is that the investment is no longer aligned with my dividend portfolio's goal of building an ever-increasing source of dividend income. Some have argued that certain securities are good value plays after a dividend cut. This may or may not be true, but my dividend portfolio's primary objective is dividend income, not capital gains. I have a separate portfolio for that. To date, I have not transferred any dividend stocks to my capital appreciation portfolio.
Finally, some will say that it was the "right" thing to do for the company to cut the dividend given the circumstances. In many cases, I do not disagree. However, in the cases I have been involved with the company was not "given" the circumstances; they created them through their own actions. If a company was truly a victim of circumstances, which couldn't possibly be foreseen or planned for, I would gladly cut them some slack and consider an exception to my rule. This situation rarely ever comes along.
Disclosure: No position in any of the aforementioned securities.