As dividend growth investors, we invest a lot of time and effort into the process of selecting and buying our dividend growth stocks. However, far too many retail investors spend far too little time thinking through when to sell. Unfortunately, this lack of sell-side planning often allows emotion to creep into the picture at the worst possible time. Let’s look at 3 reasons you should sell a dividend growth stock… and when not to!
Before we dive into the 3 reasons you should sell a dividend growth stock, let’s explore why you shouldn’t.
As I mentioned, we all tend to invest a lot into our stock-buying process. This investment is definitely warranted. The best way to avoid having to deal with selling a dividend growth stock is to avoid buying problematic ones in the first place. If you build a solid portfolio of quality companies, you are far less likely to have to worry about selling them.
As dividend growth investors, our underlying goal should be to hold a portfolio position as long as possible—never selling it if possible. We want to continue to build our yield-on-cost (YOC) and capture ever-growing passive-income streams over the long run. To echo the sage advice of Buffett, “Our favorite holding period is forever.”
Always “know what you own and know why you own it” (Peter Lynch), and never buy a company you don’t plan on holding forever.
Thus, the answer to the question of when not to sell a position is simple: 99% of the time!
However, this investing strategy doesn’t mean that there aren’t any valid reasons to sell. While these reasons (aka sell triggers) should be relatively rare, you need to clearly define what they are ahead of time. We want to be as mechanical and unemotional as possible when it comes to our decision-making process. Emotional trading is almost never a good thing and typically leads to poor decisions and losses. Thus, you need to establish clearly-defined sell triggers as part of your investing plan.
Let’s examine three common triggers for selling a dividend growth stock, as well as some additional things you should consider and evaluate.
Dividend growth is the heart and soul of our strategy. It is this growth that improves our yield-on-cost over time, fuels our passive-income stream, and builds our total return. Obviously, the opposite of this is a shrinking dividend or, worse yet, no dividend at all!
Companies take their dividend payments very seriously. There is a lot of pride in establishing a long history of dividend payments—especially ones that have consistently
grown there’s. The investing community has coined a long list of names to bestow on companies that achieve different levels of consistency with their dividend growth (e.g., dividend aristocrats, dividend champions, etc.).
As such, companies will do almost anything possible to avoid cutting their dividends and damaging their reputation and dividend history. Furthermore, they know lots of investors invest in their company for the dividends. They understand that a large number of these dividend investors will jump ship if a cut occurs–resulting in significant and likely lasting market-cap loss for the company. Thus, when they have no choice but to cut, it’s bad news… really bad news for dividend growth investors.
Having said that, you need to understand that there are certain asset types that can have fluctuating dividends or distributions. Additionally, there may be an acceptable short-term reason for the company’s decision to cut (i.e., one that may provide greater value in the long run). In these cases, you may need to factor this into your decision-making process.
However, except in the rare cases just mentioned, my hard and fast rule is that a dividend cut is an immediate trigger to sell. I always have solid dividend-growth options waiting in my “on deck” circle that I can quickly and smoothly transition into.
As a dividend growth investor, you should be performing regular checkups on the companies in your portfolio. I would recommend quarterly reviews but semi-annually at the least.
If you begin to see significant deterioration of the company’s fundamentals, you need to take notice and place it on a much more closely monitored watch list. One particular area I keep a close eye on is the performance of management. If a company consistently
misses earnings estimates or consistently underperforms against its competition—without a clear plan in place to correct the problems, it is red flag that there’s a bigger problem and a potential sign you could have a broken company.
A broken company is a trigger to sell their dividend growth stock!
Just as there is a difference between a good value-play and a bad value-trap when we buy dividend stocks, the same holds true for companies we hold in our portfolios. We want to continue to hold quality companies and capitalize on additional value opportunities they may present to add to our position and improve our YOC. However, we don’t want to hold onto broken companies that are only going to continue to decline and diminish our total portfolio returns.
No matter how good a dividend is, it can’t overcome the valuation cost of a broken company.
General Electric Company ($GE) is a perfect example of a broken company and a proof-of-concept for this trigger. The company underwent a reasonably lengthy decline due to deteriorating fundamentals prior to initiating two final dividend cuts. There were plenty of signals that it was time to sell… yet many retail investors just kept emotionally clinging to the hope that it was all just a bad dream and they’d eventually wake up to a strong and vibrant GE recovery.
Had they recognized the writing on the wall and unemotionally pulled the sell trigger before waiting for the first (or even second) dividend cut, they could have preserved a lot of capital—capital they could have reinvested in other quality value opportunities.
In fact, from December 23, 2016, GE stock fell 25% leading up to the late-2017 announcement of the first 50% dividend cut. And then it dropped another 47% leading up to the late-2018 announcement of the final dividend cut to one penny! Not only did many dividend investors hold past the first dividend cut (a clear sell trigger) but some even held past the final cut until they finally capitulated for a total loss of 65-75% from the stock’s December 2016 highs!
The fundamentals told the tale of the tape long in advance of the first dividend cut announcement. Those investors who had clearly-defined sell triggers—especially parameters for deteriorating fundamentals and management performance—were able to execute the correct decision and save themselves for an unnecessary loss.
But even employing a steadfast sell rule when dividends are cut would have prevented a waterfall loss for many, many retail dividend growth investors who, sadly, did not have one and just kept emotionally holding on to the company in their portfolios.
The world—including the global economy—changes over time. While we buy dividend growth stocks with the intention to hold forever (or at least a very long time), we simply can’t anticipate all the changes that will occur over time. These changes can significantly impact a company’s business model.
The third sell trigger I employ with my dividend growth portfolios pertains to business models. If I feel a company’s business model is no longer sustainable, then my case for holding my position in that company no longer exists—and I’m selling.
A potential example of this is Iron Mountain Incorporated ($IRM). The core of the company’s business revolves around the storage of physical documents. While their facilities are very impressive and highly-secure, the question becomes: Does the company’s current business model provide investors with a real future—one with growth?
With the shift to digital documents and cloud storage in full swing via widespread macro-shifts in technology, will there be a growing need for physical document storage? Obviously, there will always be some level of need for this type of storage… but will it be an increasing or decreasing need?
This isn’t a question of the near-term fundamentals. Rather, it is a question of the long-run sustainability of the company’s current business model.
While Iron Mountain is attempting to adjust its business model by diversifying into other storage methods and services, the jury is still out on whether it will ultimately be successful. I do not have a position in IRM; however, those dividend growth investors who do must answer that questions for themselves and pull the sell trigger if they believe the long-run outlook for the company’s business model bears too much risk for the expected return.
[Note: In my personal opinion, I don’t think the uncertainly with IRM’s future has risen to the level of a sell yet. I would not personally initiate a new position in the company today or likely add to an existing one, but I would hold my position if I had one and continue to monitor the situation.]
There are two other events that raise my investor antennas as possible precursors to a trigger event: Acquisitions and Spinoffs.
These events warrant close scrutiny and a very watchful eye.
Acquisitions can be a positive development; however, they can be negative if they don’t add value or are accomplished by leveraging excessive debt to finance it. It is also worth noting that a good acquisition can’t fix a broken company. You need to carefully evaluate the near- and long-term impacts and implications of acquisitions.
Teva Pharmaceutical Industries Ltd. ($TEVA) is a good example of what can go terribly wrong. Teva conducted a string of acquisitions, while neglecting its in-house drug R&D program. These acquisitions required a huge increase in debt, while delivery very little increase in revenue—what we call getting very little bang for the buck.
In fact, total long-term debt increased 290% from 2015 to 2016, with only an 11.5% increase in revenue. This debt remained at excessive levels as of the close of 2018, while revenues have actually fallen below their 2015 levels!
Now Teva is (or was) a growth stock and non-dividend payer… but it demonstrates the danger of highly-leveraged acquisition(s), which happen in the world of dividend growth stocks too.
On the other side of the M&A realm, spinoffs can be equally concerning. While they may be a positive for dividend growth investors (e.g., the spinoff of a low-margin or unprofitable business unit), they can also reduce the company’s remaining revenues. This drain on revenue can ultimately result in a rising dividend payout ration and, potentially, a dividend cut.
If a company in your portfolio is involved in an acquisition or spinoff, you need to very carefully evaluate the situation—it may be a sign that a sell-trigger will be activated in the future.
Finally, I would argue that there are two more events that warrant consideration when it comes to your dividend growth portfolio: Rebalancing and Relative Opportunity.
Over time, your portfolio allocations will drift from your targets—caused by unrealized gains and losses. We definitely want to make adjustments to reduce our allocation variances when they rise to a material level.
One option is selling overweight holdings and reinvesting the capital into underweight positions. This is effective; however, I do not recommend it because it (1) violates our buy-and-hold strategy and (2) can sacrifice high YOC for low YOC.
Instead, I prefer to rebalance my portfolios by bringing under-allocated positions up to my targets via purchases with new capital inflows rather than selling to add. It may take longer to achieve your rebalancing going this route, but I believe it is the most effective way of accomplishing it.
We use M1 Finance for our dividend growth portfolios—including our site’s viewable passive-income portfolio. I highly recommend this broker/platform because it is not only free and allows you to purchase fractional shares, but it provides you with a great investing algorithm that automatically keeps your portfolio balanced according to your targeted allocations. It’s like putting your portfolio on auto-pilot.
However, I need to point out that M1 also provides you with a one-click “rebalance” button that will immediately and manually rebalance your portfolio. It is critical that you understand that using this feature (rather than letting the portfolio auto-balance through additional purchases) will cause a proportional sale of every position that is overweight! The cash generated from these sales will then be re-invested into your underweight positions.
This will not only cause a taxable event, but it will trigger sales of your dividend growth stocks. Again, I would not recommend using the “rebalance” button—it’s kind of a dividend growth portfolio nuclear option—there if you need it in a worst-case scenario… but certainly something you want to avoid using if at all possible!
If you’re interested in starting your own M1 Finance dividend growth portfolio, please consider using our referral link https://mbsy.co/sZVS3 and we’ll both get some free cash!
As with any investment, dividend growth investors need to consider opportunity cost and relative opportunities. There may come a point when one of your positions will experiences so much rapid growth that it just makes sense to trim your position a bit, capture the capital gain, and reinvest in new value opportunities.
I will argue that trimming winners is generally a bad investment idea. In essence, you are (1) trading a known winner for a new, unknown option and (2) shifting your portfolio allocation toward underperforming, inferior positions.
I don’t trim positions in my dividend growth portfolios but if I was to trim, I would start with what I considered to be my worst positions—not my best ones.
The decision to sell for another relative opportunity is a personal decision. It’s not part of my strategy, but that doesn’t make it wrong. If you employ this as part of your strategy, just ensure you have a clearly-defined system to determine when, how and what you will trim.
Dividend growth investors tend to devote enormous effort and time to selecting stocks to buy, but neglect addressing the matter of when and why to sell. An unintended consequence of this is the potential introduction of emotion, which can cause us to make poor investing decisions at the worst possible time.
We can avoid this by establishing clearly-defined sell rules (or triggers) that enable us to make mechanical, unemotional decisions when the time comes to pull the trigger.
I recommend three automatic sell triggers for dividend growth stocks:
Outside of these three clearly-defined triggers, I rarely sell. Dividend growth is all about patient, long-term investing. I prefer to employ passive management rather than an active, higher-turnover type of portfolio management.
You had a plan when you selected a dividend growth stock… trust your strategy and let it play-out over time!
There are also two additional events I stay on the lookout for:
These could potentially lead to the eventual activation of a sell trigger and I like to be ahead of the game—not behind the power curve.
Finally, I maintain the allocation balance of my portfolios through purchasing underweight positions—not selling overweight ones. This allows my portfolio to grow into balance. I also do not typically engage in selling dividend growth stocks based on relative opportunities—it violates my buy-and-hold strategy and is simply too subjective.
In the end, each dividend growth investor must develop their own set of sell triggers. This article has laid-out my approach and recommendations, but yours may be very different based on your investing plan and unique situation. There’s no right or wrong system.
What matters is that you have one—meaning a mechanical, consistent, and unemotional system in place ahead of time to help you know when it’s time to sell a dividend growth stock!
Here’s a great video from Morningstar. It’s a little dated but provides some additional insights and perspective regarding when to sell dividend growth stocks:
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