As a dividend investor, I carry a buy and hold mentality with each stock purchase. Once a stock enters my portfolio, it rarely leaves. At least, that is the plan. However, as we all know, whether it is investing or life, circumstances change over time and we have to adapt to the constantly changing environment. For our investments, not all changes are positive and the changes may force us into a corner. Do we continue to hold the stock? Or do we sell? Man does it suck typing that word out. In this article, I am going to discuss 3 scenarios that would cause me to consider selling an investment and review my portfolio to see if any of my holdings fit 1 of the 3 descriptions.
The Sell Scenarios
Before I begin, I want to point out that this list is not all-inclusive and I am sure there are plenty of other metrics or trends that you all and Lanny use to identify when it is time to sell a stock in your portfolio. So if you look at something different, please share your methodology in the comment section so we can all learn! This is great because of everyone’s willingness to share and receive others investors’ knowledge to grow as both an individual and DGI. With that being said, let’s dive in and see how I determine if I should sell a stock.
Scenario #1 :Current and Forward Payout Ratio Close to or Exceeding 100%. There are many events that may cause a company’s payout ratio to increase post-purchase. (Note: I use the phrase post-purchase due to the fact that our stock screener uses a payout ratio threshold of 60% [Excluding REITs]. So I am making the assumption here that we would not have purchased a stock with this high of a payout ratio, indicating that an event caused this metric to increase). The company could have revised their earnings estimates due to poor performance, a change in the company’s operating environment such as a drop in crude oil prices, etc. or the company simply could have increased their dividend recklessly to an unsustainable level. While we hope that we would never invest in a company that would partake in the latter scenario since we try our best to invest in a growing dividend stream, we still don’t have a clear crystal ball for the future, otherwise none of us would be working right now! For me, when I see a payout ratio reaching the 100% level, I start to get worried about the long-term safety of the dividend and start plotting an exit strategy. Lanny and I have been burned by missing this metric before and I will dive into that story later on in the article because like all experiences, I learned a great lesson from it.
There is one other point I want to clarify here. I purposely set the payout ratio threshold close to 100% to avoid “Payout Ratio Creep.” Okay, you caught me, I just made that term up. But if it becomes a thing, remember that you first heard the phrase here first! What I am referring to is the short-term increases in a company’s payout ratio to levels that are sustainable but higher than I prefer. A great example of this is Procter & Gamble. Right now, PG’s current payout ratio and forward payout ratios are ~78% and ~63%, respectively; both of which are above the 60% threshold in our stock screener. Since PG typically runs a high payout ratio and has a great track record of increasing their dividend, I am not overly concerned about the safety of the dividend because their current earnings still cover their distribution to shareholders. But am I watching closely…of course…especially since PG had a poor dividend increase this year. Perfect transition to the next scenario.
Scenario #2: Several Unexpected Years of Dismal Dividend Increases. Before everyone calls me a hypocrite considering my recent purchase of Consolidated Edison, let me explain myself here. With this metric, I am referring to a stock that has a recent history of large dividend increases that would suddenly slam the brakes on increasing their dividend over multiple periods. Using made up scenario to demonstrate this, let’s assume I recently purchased Lowe’s, one of Lanny’s Top 5 low dividend yield, high dividend growth rate stocks. One of the reasons I would have purchased LOW is due to their 5 year average dividend growth rate of 20.81%. Phenomenal growth rate, right? While that growth rate is not sustainable over the long run, I would consider selling the stock if the next two annual dividend increases were sub 5%. I know the scenario is dramatic and it is highly unlikely to happen, a sudden decrease in the dividend growth rate would negate one of the main reasons I invested in such a stock and pose many questions about the long-term health of the dividend. If you want a great real example of this, look no further than Dividend Mantra’s sale of Sysco in November 2014, where he cited poor earnings and dividend growth over the last several periods as one of the reasons he sold the stock. This is much different from a company like Consolidated Edison, which I purchased because of their higher yield, our belief that the company is a foundation stock for a dividend portfolio, and the company’s long-term record of dividend increases (I am not saying the dividend increases have been great, just that they have increased their dividend). To me, the key to this point is the UNEXPECTED dismal increases.
Scenario #3: Uncertainty in the Company. I might as well call this the ARCP metric and we are all pretty familiar with what has happened to ARCP over the last year, so I won’t dive into the detail to explain this example. Honestly, once again, Dividend Mantra does a great job describing this point in his article summarizing why he sold ARCP. Unfortunately, periodically, a dark cloud of uncertainty can roll over a company and us an investors really have no idea what the future may hold. This dark cloud can come from a substantial change in government regulations/laws, the discovery of fraud, the sudden resignation of the management team, and so on. What sucks about this scenario is that you are most likely going to sell low because you will most likely be blindsided by the development and the market will react before you. However, sometimes it is better to just cut your losses and move on to a stronger dividend stock. Since I am a buy and hold investor that focuses on building a reliable dividend stream, any sudden news that impairs my ability to rely on the future of a company’s earnings or dividend is not welcome news and will result in me looking to sell the stock.
Again, as I mentioned earlier in the article, this list does not represent every metric, trend, or event that could occur that would cause me, Lanny, or any of you to sell a stock. Sometimes, your decision to sell could be as simple as “This stock does not fit my portfolio any more” or “I prefer Company B to Company A.” While those impulse decisions are great and I have made a few of them myself over the years, the three scenarios listed above are the most likely reasons I would sell a stock out of my portfolio. So now that I have spelled out my secret strategy, let’s see if there are any stocks in my portfolio that I should look to sell.
Portfolio Review
After writing the first part of this article, I scrubbed my portfolio to see which stocks may be candidates to sell and re-allocate the capital to stronger dividend paying companies. Hopefully this list is short!
Stock #1: FirstEnergy Corp (FE)- I think Lanny’s heart just sank a little bit everyone, because it may be time to sell this stock from his hometown of Akron. FE’s current payout ratio using TheStreet.com’s FY 15 earnings is 55%, so it is not due to the fact the company’s payout ratio is no longer unsustainable. Did anyone catch the keyword phrase in the last sentence…”no longer.” Ah, yes, remember how I mentioned that Lanny and I learned about payout ratios exceeding 100%? The Akron company was the teacher of this lesson and the story behind it is even funnier. One day I was driving to the rec and Lanny called me with a concerned tone in his voice. I picked up the phone and all he said was that he believe FirstEnergy is about to cut their dividend because they have yet to announce their dividend for the year (At this time, we were at least three weeks past the typical announcement day) and their payout ratio was well above 100%. Seriously, he didn’t even say hi! His gut was telling him that bad news was coming and man was he right as within the next week FE slashed their quarterly dividend from $.55/share to the current $.36/share. After this episode, I am always on the lookout for stocks with payout ratios greater than 100%.
So many of you may wonder why am I holding the stock, especially because the dividend cut was six quarters ago and FE has not increased their dividend? My response is that is why the company is now on my selling block. I would prefer to hold a company such as Consolidated Edison, that offers the same yield with some annual dividend growth as opposed to a company that has recently slashed their dividend and had a history of maintaining a flat dividend even before the cut. I left this reasoning out of the article I wrote about purchasing ED intentionally I wanted to get everyone’s thoughts about the asset I purchased. However, this realization about FE also played a major part in my position to purchase ED so I can transition my allocation of electric utilities to a company that I believe is a stronger dividend growth company.
Stock #2: BP (BP)- BP is a company that is on my radar, but I am less likely to sell my stake in BP as opposed to FE. BP earned a spot on this list due to the depressed crude oil market, which lowered the company’s future earnings and caused the forward payout ratio to spike. Using TheStreet.com’s estimated FY ’15 earnings and the annualized current dividend of $.595/share, the company’s forward payout ratio is 93%. Plus, BP always seems to be in the news for new fines/liabilities associated with the large oil spill from several years ago. With uncertainty in the industry and the high forward payout ratio, I could transition my stake to a stronger company such as Exxon, increase my stake in Chevron, or use the funds to invest in a separate industry altogether.
Stock #3: GlaxoSmithKline (GSK)– Using the same resources listed above, GSK currently carries a forward dividend payout ratio of ~100%, hitting my threshold right on the head. One trend that alarms me is the decrease in quarterly dividends from most European companies recently, as many company’s have elected to reduce their dividend from the comparable quarter last year. This is one of my annoyances with European companies, as I prefer the scheduled/predictable quarterly payouts that are present for most US companies. There are plenty of other drug manufactures.healthcare companies that I could invest in at the moment, such as JNJ which Lanny recently purchased and is on our most recent watch list. So I have alternatives options that may provide greater dividend safety if I chose to divest.
Summary
Looks like I may have a sell or two to make in the next couple of weeks. While selling a stock is not an easy decision, because quite frankly, none of us want to admit we are wrong, sometimes it might be the best move you can make to improve the quality of your portfolio and dividend income stream. I would like to challenge all of you to take the time in the next couple of weeks to review your portfolios and see if there are any stocks that may no longer fit your investing strategy. For me, this has been great, especially as I have been looking for ways to invest in some of the companies that have fallen out of favor recently. Selling a stock that no longer fits my investing is another source of capital that I would gladly use if the right move presents itself.
What other metrics do you use to determine if you should sell a stock? Would you sell FE, BP, or GSK based on their metrics? Or would you continue to hold the companies and collect their juicy dividends? What are your thoughts on the three metrics I use? I am really looking forward to your comments everyone!
-Bert