Kinder Morgan (NYSE:KMI) has been a stalwart of many DGI portfolios for many years, but recently, after a very large drop in price, it cut its dividend by 75%. There have been many articles written about this, a lot of discussion, and there seems to be a lot of anger out there, directed at KMI and Richard Kinder. But concerning investment strategies, as a general statement, I've seen comments to the effect that the significant drop in price and the subsequent dividend cut, shows that DGI is not an effective long term investment method.
"KMI has exposed the weakness in DGI & the temptation of reaching for yield."
There are many lessons that can be learned from the KMI experience, including lessons about stock evaluation, debt levels, cash flow, etc. But that the KMI dividend cut exposed a weakness of DGI is not one of them. Every dividend growth investor knows that a dividend cut is a possibility for each and every one of the stocks they own. The possibility of a dividend cut is not a weakness of DGI. It is just a feature to be dealt with, just as an earnings miss for any particular stock is a possibility that a growth portfolio would have to deal with. It is how you prepare yourself for a dividend cut, and how you protect your portfolio that matters.
To me the main lesson to be learned from the KMI cut is about diversification. "Diversification" can mean many things to many different investors. To me it means holding enough dividend paying stocks so that if any one of them cuts its dividend, my total income will not be too severely affected. One SA commenter asked:
"Why is SA still running five articles a day on KMI even after it destroyed countless investors the past 8 months via a 75% dividend cut and 63% decline in share value?"
But a responsible DGIer would never let any stock become such a large part of their portfolio that a single dividend cut could "destroy" their portfolio. The first priority of a dividend growth investor is to protect their dividend income. I diversify my dividend payments amongst many different stocks so that no one stock has an over-sized effect on my income. By diversifying, in terms of the number of positions you own, you minimize the effect that any one stock can have on the portfolio as a whole. The KMI dividend cut is a perfect example of this.
So let me show you exactly what KMI did to my portfolio.
On April 23rd, KMI hit its all-time high of $44.57. At that time I owned 712 shares. Had I been brilliant enough to know what would have happened to KMI over the rest of the year, and sold at that absolute high, I would have received $31,733. But of course I didn't sell it. In fact, this past fall, with the price down to about $26, I bought 200 more shares which, with some dividend reinvestments I had received, brought my total number of KMI shares to 920.
But then, on Tues. Dec 8th, KMI announced it would cut its dividend by 75%. So, as per my investment plan, I sold all my shares for $16.27 per share, receiving $14,968.92.
Effects on my portfolio value
Let's assume I actually sold all my shares at KMI's absolute high price of $44.57 (Not likely, but let's go with the worst case scenario for how much I've lost). I would have taken in $31,733. And we can assume that I would not have bought 200 more shares in October. So, subtracting the $14,968 I actually did receive when I sold it from the $31,733 I could have received equals $16,765, which we could claim I "lost" by holding onto KMI. The present value of my portfolio is about $1,030,000, so the $16,765 I "lost" comes to about 1.62% of my portfolio. I would hardly say that this "destroyed" my portfolio. Considering that the S&P was down about 6% the first week of 2016, the 1.62% I "lost" with KMI is almost inconsequential.
Effects on my dividend income
Now let's look at the effect on my dividend stream, which to me is the most important part of my portfolio.
Prior to the dividend cut, KMI had paid $.51 per share as its last declared dividend. If we assume that it maintained that dividend rate for the next year, it would have paid $2.04 per share. Therefore the 920 shares I had at the time I sold would have produced $1,876.8 in dividends over the next year. With the money I received from selling KMI, I bought 141 shares of Ameriprise (NYSE:AMP). Ameriprise presently pays a dividend $2.68 per share (yearly), so over the next year, assuming no change in the dividend, those 141 shares will pay me $377.88. So the loss of dividend income I have suffered due to the KMI dividend cut, and my subsequent selling of the shares, is $1,498.92 ($1,876.8 minus $377.88).
With the present make-up of my portfolio, which can found here, the estimated dividends I will receive in the next 12 months (ED12) is $41,489.45. However, if KMI had not cut its dividend, and I had not sold it, I would have expected to receive $42,998.92 over the following year, a difference of 3.49%. So the "destruction" of my portfolio due to the KMI dividend cut only amounts to a decrease of about 3.5% to my dividend stream. And yet it will still be a record year for me in terms of dividends collected, and with the dividend hikes I expect from most, if not all of my stocks in the coming year, that 3.49% difference will most likely be wiped out pretty quickly.
The point I'm making with the above math exercise is to show how diversification can protect your portfolio from a dividend cut. At no time did KMI make up more than 3% of my portfolio in terms of value. And it never made up more than 4.5% of my dividend income, even though it was my largest position. And therefore at no time was my portfolio at significant risk due a dividend cut from KMI or any other stock. Most dividend growth investors I'm familiar with own at least 20-30 stocks, most hold 40-60, and some hold over 100. I feel it is essential, if risk control is one of your investment goals (and it should be), that you hold enough positions in your portfolio to minimize the effect of any one dividend cut.
In a well-constructed dividend growth portfolio, no stock should be allowed to become responsible either for too much of the value of the portfolio, or too much of the dividend income. By diversifying the portfolio in terms of how many stocks contribute to the dividend stream, it minimizes the risk of a dividend cut from any one stock.
Thank you for reading my article. I welcome your comments and criticisms.
Disclosure: I am/we are long AMP.
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.