Dividend stock investing involves a lot of research. Investors should look into total yield, the history of dividends, dividend payout ratio as it relates to total profits, track record of increasing distributions and more.
But what happens when you find an appealing dividend stock and it doesn’t live up to expectations? Investing for dividends is naturally a buy-and-hold affair, since you want quarterly paydays over time, so when do you know when it’s time to sell your dividend stocks?
Some dividend investors think that their stocks should be held forever. If that describes you, then the answer to the question of when to sell is simply “never.”
But other dividend investors find quarterly payouts nice but not a game changer; the real value to them comes in rapid share appreciation. If that describes you, then obviously you’re not asking when to sell a dividend stock — you’re wondering when the best time to buy and sell is based on the best share price, with the dividend barely even entering into the picture.
For those dividend investors who fall in between, pulling the trigger on a dividend stock is a balancing act. They grant some leeway to stocks with a hefty and reliable payout when shares slip, or they’ll stick with a stock that has slashed its dividend because it has upside potential for shares in the long term. But where do you draw the line?
There are five conditions that are helpful in sounding the sell signal for any dividend stock investor.
The company cuts or altogether eliminates its dividend. This one is fairly obvious. A company that keeps dividends flat for a few years may be worth hanging on to, but if a company is slashing dividends it is an ugly sign. Sometimes it means the balance sheet has gotten so bad that it needs to literally take money out of shareholders’ pockets to restructure or prop up an ailing business. Case in point: embattled mobile phone maker Nokia (NYSE:NOK) which just killed its dividend to preserve capital.
The dividend stock sees its annual dividend yield drop below 1%. There are plenty of stocks out there that offer a nominal dividend just to qualify for certain institutional portfolios. For instance, a fund that boasts in its prospectus that it is comprised of dividend stocks can dabble in small-cap companies that pay a penny per quarter without running afoul of its core strategy. But if a company’s dividend is below 1%, chances are it’s not a dividend stock in the true sense. It’s just a stock that happens to offer a dividend. Besides, if dividends are an afterthought for companies, there’s no guarantee that they will make an effort to maintain or boost their payouts.
Your initial dividend stock is acquired or suffers a spin-off. Frequently, big buyout deals are made with a lot of cash — meaning the cash-rich company being absorbed is going to have to pay some bills before it continues returning capital to shareholders. So don’t hold your breath waiting for a history of strong dividend increases to materialize at the newly merged company. Similarly, companies sometimes spin-off disparate parts of their businesses — but that doesn’t mean that hanging on to the parts is as good as holding onto the whole was.
Your position in the dividend stock is down 50% or more. Though small fluctuations in share price are not necessarily a problem for dividend investors, watching a position get hacked in half should set off big warning bells. If Wall Street is rooting against this company so much, you have to believe that the dividend is at risk. Furthermore, a dividend stock with a yield of about 2% will take 50 years to “double your money” via dividends — or pay for itself, depending on how you view your investment. If you have to wait 50 years to recoup your 50% decline in share price… then that’s just not realistic.
Your “yield on cost” for the specific stock is below 2.5% after five years. This one is a bit arbitrary and takes some math. But the spirit is to avoid a dividend stock that languishes in both share price and dividend payouts. Let’s say you bought shares of stock XYZ at $50 a share. At the time, it paid a $1 annually in dividends for a yield of 2.0%. Five years later the dividend has been increased just a dime to $1.10 — so your “yield on cost” is 2.2%. If you’ve gotten zero share appreciation and after five years the stock is still yielding less than 2.5%, why not just move your money? It’s not a tall order to find a similar stock that yields 2.2% or better, and hopefully the new dividend stock will increase its payouts and move higher at a better clip than your dead-money investment did.
Selling a stock is always difficult. But you’ll be better served in the long term finding a stronger dividend stock that will deliver reliable returns.
Though it’s tempting to believe a dividend stock will fight back, it’s often quicker to make up for a loss in a good stock than leave your money parked in a laggard.
Think of it this way: If you find a stock with a similar yield that provides the exact same performance going forward, all you’re out is your broker fee. So unless you are convinced there is no better investment out there at this moment in time, it could be time to dump some of your dividend stocks and move on to greener pastures.
- Find some great dividend ideas with Dividend Growth Investor’s blog. (Dividend Growth Investor)
- Remember, reaching for yield can hurt you. The +10% group typically has a big dividend yield because of underperformance — not huge payouts. (The Slant)
- Mark Hulbert on where to find the best dividend stocks. (WSJ)
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at email@example.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.