We often hear a rule from dividend investors that a dividend drop triggers a sell and I am not so sure that a drop should automatically trigger a sell. Sure, it changes your future income but I would imagine that in an overall portfolio, one stock dropping the dividend will not dramatically impact the income. The biggest reason to consider the sale is the potential loss you may incur in doing so.
First of all, if you sell on the announcement, chances are you are losing money as I believe the dividend drop is the last of all the warning signs that the dividend was not sustainable. If you are still holding the stock when the dividend is dropped, in my opinion, you either ignored all the warning signs or you made the decision to hold through. What do you think? I am sure there are scenarios where it’s not the case, but generally, a high dividend above 6% tend to be abnormal and the payout would highlight it. REITs operate under different rules as well as some other corporations. The warning signs are usually present in the leading quarters starting with the high yield and a high dividend payout ratio.
Another factor that can force a company to reduce its dividends is the economical factors surrounding its business for which they have no control over. Let's start with the banks back in 2008. While the Canadian banks were strong and not exposed to the sub-prime mortgages, the Basel III rule instituted to create strong financial institutions had an impact and most of the major banks opted to not increase their dividends. I understand it’s not a drop but they were impacted nonetheless. The next industry to being caught is the oil industry. The cost of a barrel of oil has dropped significantly that many companies had to adapt to the changes by reducing expenditure and some had to actually reduce the dividend. When an economic factor is the reason, there might not be a lot of warning signs or a lot of time to react to the warning signs.
With the above 2 points, do you still believe that you should sell on a dividend drop? In some cases, you actually have to take a lost. Kinder Morgan (NYSE:KMI) is an example of a company that changed its policy and still pays a decent yield but they were a strong dividend grower for a long period of time.
For the record, I have not sold CPG (CPG) (TSX:CPG) or POT (NYSE:POT) (TSX:POT). The prices of natural resources are a factor that cannot be predicted. Other countries in the world can impact prices at the last minute and it doesn’t mean the company is not a good investment. What is most important is for management to be smart and manage growth for both stock value and dividends in future years. We are not always in bull markets so when the bear market hits, it’s important to be cautious.