Many dividend growth investors will tell you that when to sell a dividend stock is one of the hardest decisions to make.
This can be evidenced by the poll I ran this week on Twitter, just in the lead-up of writing this article:
This may sound awkward, but our minds are really wired into buy and hold thinking.
Generally speaking, when we buy, we buy it to never need to sell again.
Hence, most of us educate ourselves a lot in how to screen for companies using a dividend stock screener.
We then spend some time on understanding the company and analyzing their main financial statements. This ultimately leads to the decision on whether we want to initiate a position in the company, or not.
This by itself is for many new dividend growth investors already a steep learning curve.
It is however a practice we tend to do a lot and over time this leads to a pretty well defined routine.
But deciding when and how to sell a dividend stock is different. Most of us rarely do this and there are several reasons for this:
- We focus on dividend income over price appreciation
- We might “fall in love” with a company
- Businesses that are doing well tend to grow their dividend income over time and increase our yield on cost. And many of us love Yield on Cost!
- We simply don’t know what to do
Unfortunately, I had to sell some of my dividend stocks several times over the past 6 years. I had to reflect on this and make sure that I took my learnings from it..
But while researching, I found that there are generally two schools of thought on when selling dividend stocks.
And today I would like to share both with you in the hope that it helps you in shaping your own decision making process.
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1. Selling a dividend stock straight after a dividend cut
There are many dividend investors out there that will sell a dividend stock straight after a dividend cut, no matter the circumstances and the reasons provided.
The most mentioned reason for that is to take out any psychology in the decision making process.
And in my opinion this is a very strong argument.
As an example, it avoids having issues to sell after you fell in love with a stock. And don’t worry, this all happens to us!
So in this case, the strategy is really simple:
Sell the shares, take the money and invest it elsewhere.
It may hurt in the short term, but this ice-cold behavior should benefit us in the long-term.
But there is a counter-argument to this strategy which you will hear a lot:
“After a dividend cut, the stock price might hit rock bottom and you will miss out on a potential rebounce in share price.”
But the question then is: are you really a dividend growth investor?
From my own experience I can tell you that I should’ve followed this philosophy when General Electric cut their dividend the first time back in September 2017.
As you can see, the stock was still trading at an amount of $190 per share. Nowadays a pays 8 cents of dividends per quarter and trades at about $100 per share.
I had no idea if the company would go up or down at the time.
I realized that I had confirmation bias and I was ignoring it.
Hence, it was clearly a bad decision from me and I should have sold them straight away at the time.
I didn’t do it and I still own 60% of that position.
It serves as a reminder and at the same time I use it every December for tax-harvesting.
But GE was not the only one that cut its dividend since I started to build a dividend growth portfolio back in 2016.
I also decided to sell my shares in Disney straight after their dividend cut last year. Many people told me that it was a stupid decision, because of their Disney+ asset.
However, I am a dividend investor and suddenly I lost some income. That’s why I replaced the income with buying shares in Chubb Limited at $100 and a 3% yield at the time.
In hindsight this was a successful move, because I got more dividend in return and an almost equal appreciation in share price.
I like to tell myself that this is a result of my learnings from the $GE mistake.
Having said that, this was the first typical school-of-thought you will hear in the dividend growth community.
So what about the second one?
2. Selling a dividend stock after the fundamentals of a company have changed
This strategy is much harder for most of us, because it suggests that we are intelligent investors following a value investing strategy.
And there are several reasons why I consider this harder, because it costs quite some time to:
- Keep a close track on market dynamics
- Analyze annual results and monitor quarterly reports
- Assess the dividend safety of a company
But let’s assume that you have this time on hand and that you’re very passionate about investing (like me).
In that case there are several elements I would pay attention which are related to the 3 financial statements (income, cash flow and balance sheet):
(a) Sales & Earnings
A growing company typically shows increasing revenue growth which trickles down to the earnings per share.
This is in combination with stable or increasing margins over time a sign of pricing power and market dominance.
Hence, anything antipattern to this should be considered as a warning sign.
(b) Free Cash Flow
Dividends are paid from cash. Continuous year-over-year increasing free cash flow per share is what you want to see.
Deteriorating free cash flow is a red flag.
(c) Balance Sheet Strength
There’s nothing worse than a poor balance sheet during an economic downturn.
It provides a company with a safety net in case sales and earnings are impacted by an economic contraction.
That’s why you want to see healthy balance sheet ratios like:
- Interest coverage > 3
- Debt / Equity < 75%
Anything beyond these ratios should be considered a warning sign.
Note: some industries have naturally high Debt/Equity ratios (like supermarket chains) due to their stability and predictability in earnings. This is OK and an industry perspective should always be considered.
(d) Dividend Safety
Last but not least, you would like your dividend to have room to grow. That’s why it’s important to keep track of the EPS and FCF dividend payout ratios.
Ideally these are lower than 60% so that a company has some wiggle room in case both FCF and EPS show stagnation in growth.
Hence, you want to avoid high dividend payout ratios and especially if it’s a result of the dividend per share growing faster than EPS and FCF.
Red flags for one or a combination of these elements is something which could lead to a recommendation to sell your dividend stock.
Like I said, it’s probably much harder to do, but it might prevent you from selling a stock at rock bottom.
Sometimes a dividend cut can be considered as a big reset which provides increased flexibility to a company going forward.
But the question remains then: are you a pure dividend growth investor? Or are you a combination of a dividend income and value investor?
There’s no right or wrong here, but I sincerely believe that it’s important to be able to answer this question.
It will allow you to choose the right strategy on when to sell a dividend stock.
Final Thoughts on When to Sell a Dividend Stock
These two schools of thoughts really depend on your personal investing style.
If you struggle with the psychology in investing then I would definitely recommend using the first approach.
It can make your decision process so much easier.
If you’re not sure about what I mean with that then ask yourself the following questions:
- Do I find it generally difficult to make a decision at all regarding selling my shares?
- Are there companies I honestly like so much that I can never imagine selling them?
- Can I catch myself having confirmation bias regarding the companies in my portfolio?
- Do I find it hard to take a loss?
If some of these questions apply to you, then it might be a sign that you would benefit from selling a dividend stock straight after a company announced a dividend cut.
But if you consider yourself more of a value investor who can generally keep emotions in control, then the second strategy might be a better option for you.
Last but not least, if you generally struggle with this or investing in individual stocks at all, then you can always consider investing in dividend aristocrats etfs.
There are several out there, but you need to take a careful look at their investment policies.
Not all dividend aristocrats etfs are the same and some even decided to choose a misleading ETF name.
Having said that, I’m personally following the second approach.
I consider myself a dividend growth investor using a value investing approach, but only since a year of two or so.
Disclosure: I own GE, DIS, RDSA.
Disclaimer: European Dividend Growth Investor is not a licensed or registered investment adviser or broker/dealer. He is not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
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European Dividend Growth Investor
European Dividend Growth Investor is known as the inventor of the Noble 30 index. It is a list with 30 blue chip European Dividend Aristocrats that have the longest track record in growing dividends. He operates his own blog and publishes an article at least once a week in which he shares his accumulated dividend investing knowledge, stock analysis or his FIRE journey. Besides that he also has a YouTube channel which contains his Sunday with eDGI series in which he shares his thoughts about dividend investing in a more visual way. Last but not least, he’s the co-host of the Dividend Talk podcast together with Engineer My Freedom.