Make Me Sell

by: Eli Inkrot

"You can pry my dividend growth stocks out of my heir's cold dead hands." Perhaps that's a bit of an extremist insinuation, but I would speculate that many long-term income investors do not stray all that far from this ideology. That is, they build a collection of well-known, wide moat companies that have not only the ability but also the storied track record of increasing their payouts by a rate that far outpaces inflation. Then they expect to hold on to these partnerships for the rest of their investing career, watching as their yearly purchasing power dependably trends upward.

A perfect example of this philosophy recently rang true in well-known author David Crosetti's article: "The Perfect Investment Portfolio: It's All About Income, Right?" Which can and should be read here. Within the concluding section of this article, David details how the portfolio will be rewarding his oldest daughter… 40 years from now. Of course it is probable that some of the underlying holdings could change. But then again, if you have a core of Coca-Cola (NYSE:KO) and Johnson & Johnson (NYSE:JNJ) raising their dividends for 50 straight years, Procter & Gamble (NYSE:PG) raising payouts for 56 years, Kimberly-Clark (NYSE:KMB) for 40 years, McDonald's (NYSE:MCD) for 36 years, along with a variety of similar holdings, then you probably won't need to worry about dividend growth turnover too much. More succinctly, as Warren Buffett would say, the dividend growth investor's favorite holding period is "forever".

It isn't difficult to see why people are drawn to this strategy. Consider the possible price fluctuations: a flat market, a down market and an up-market. The thing that people squabble about in a flat market, or more aptly a flat price of a dividend growth stock, is that there are better opportunities out there. That is, other companies are increasing in price whilst some dividend growth stock prices stagnant for years on end. Besides missing the boat on what a dividend growth strategy is all about, these people could also be dead wrong. In fact, I brilliantly detailed this principal in a recent article seen here. If one had consistently invested in and reinvested the dividends of Coca-Cola during a 14 year period where the average annual price appreciation was negative 0.69%, they would have made more money than if they had consistently invested in Berkshire Hathaway (NYSE:BRK.A) with its 3.65% average annual price appreciation during the same time period. In fact, KO even beats a made-up example of a company that increases in price by 5% a year and increases its dividend by 6% a year. The power of a solid dividend growth company is astonishing.

In a down market, there should be no contest. As long as the dividend growth companies keep paying and boosting their payouts, then the income investor has no worries. On the other hand, if one is invested in non-dividend paying stocks and needs income, then they're subject to the whims of market, especially in the short-term. Moreover, a down market is the time to be buying, not selling.

The up-market is the non-dividend investors best bet in forming an argument. But then again, I would caution that the long-term dividend growth investor probably doesn't care. I would like to mention that either strategy is fine with me, as long as it fits your underlying goals.

Consider a dividend growth investor with say an initial portfolio of $2 million that currently sends them $70,000 in income each year. This is enough to cover all of their expenses plus some and the payout is expected to grow faster than their expenditures for the foreseeable future. They have no intentions of ever selling even a single share of their portfolio, as long as their holdings remain fundamental. Now, does the dividend growth investor really care if their portfolio is worth $1.9 million or $2.1 million? Probably not. For that matter, do they really care if their portfolio is worth $1 million or $5 million? Again the answer is no. Sure it would be nice to log-in to your account and see a $5 million balance instead of $1 million. But if you are solely focused on income and have no plans to sell, then in reality it shouldn't matter.

So let's review. Flat market, down market or up market, the long-term dividend growth investor is likely content with watching their income grow instead of watching everyday price fluctuations. So would a dividend growth investor ever sell?

Real estate website has our answer. If you want to list your house on Zillow you have the classic options to list 'for sale' or 'for rent'. But you also have the option to "make me move". Within this option, many people name a price far above what a realtor or motivated seller might be consciously willing to. The "make me move" crowd is suggesting: "I'm not really looking to move, but if you 'make me an offer I can't refuse' then I'll consider it".

Within the long-term dividend growth investment strategy, the thought process is precisely the same: "make me sell". Flat market, down market or up-market, we've noted that the dividend growth investor has no interest in selling. But what if one of the companies you partner with is no longer fundamental in their dividend policy? General Electric (NYSE:GE), JP Morgan (NYSE:JPM), Wells Fargo (NYSE:WFC) and US Bancorp (NYSE:USB) come to mind. If a company no longer fits one's underlying investment strategy, then they must consider exchanging this ownership claim for another. Even then, it doesn't necessarily mean that you should shy away from the General Electrics and JP Morgans forever.

The second reason a dividend growth investor might consider selling one of their holdings is if the market happens to be offering a "make me sell" price. For example, let's say you wake up tomorrow and the market is offering Procter & Gamble shares for $150 or 40+ times earnings; of course you should take advantage. The same goes for the Cokes, PepsiCos (NYSE:PEP) and Colgate-Palmolives (NYSE:CL), even at say 30 time's earnings. However, even then, one might be singularly focused on the dividend income and not concerned with the underlying price. After all, one needs to find not only an alternative that beats the seemingly overpriced security, but more aptly, an alternative that beats the "make me sell" security once taxes, opportunity costs and frictional expenses are added in. Holding a dividend growth stock at say 20 times earnings is much easier to justify than purchasing a dividend growth stock at 20 times earnings. Perhaps you happen to like your Coca-Cola shares handing you a 10% yield on cost even though you realize that the price might decline in the short-term.

In the same manner that the content home owning posts their "make me move" price; the long-term dividend growth investor has the ability to consider a "make me sell" scenario. If they know that there are only two events that would cause them to sell, and even those circumstances are rather rare, then it's likely that they won't care what the market is doing on a day-to-day basis. Much like the "make me move" person doesn't really care if people go around offering them half the price of what it would take to make them pack up and find something new. If you ask me, this is a pretty cool position to be in.

Disclosure: I am long PEP, PG, KO, JNJ, MCD. 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.