Good times, Bad times
This site provides quite a bit of information on what to look for when buying a dividend stock, so this will be an article on reasons to sell a dividend stock. Knowing when to sell a stock can be hard, especially for an investor that wishes to ideally hold onto his or her stocks for a very long time. Yet, there are certain times when selling an investment is the right thing to do.
Reason 1: Dividend Cut
If an investor invests in a company seeking long-term growing passive income streams in the form of dividends, but the company they invested in one day reduces or eliminates its dividend, then it is often an appropriate time to sell. Firstly, you’ll have lost some passive income, and secondly, other income investors are likely to reduce their holdings for the same reason. Under some circumstances it may be a reasonable decision to continue holding onto the stock, but in many instances this is one of the most clear-cut red flags that it is time to move on.
Reason 2: Major Change
If a company changes dramatically, its usefulness as an investment to you might change considerably. For context, consider reading my previous article about writing an investing thesis. In that article, I discussed the merits of writing down and saving your investing thesis, which is your summary of qualitative and quantitative reasons for purchasing the stock of that company. It’s good practice to periodically review your investments and ensure that you still own them for logical reasons. If the company has changed significantly from the way it was when you purchased it as an investment, your reasons for purchasing stock in that company may no longer exist in that company. Examples of major changes that may affect your interest in holding the stock are massive acquisitions and mergers, or a re-focusing of the business, or a huge macro-economic shift, or that the company is increasing their debt beyond the point that you are comfortable with.
Reason 3: Overpriced
“Buy low and sell high” is the mantra of a lot of investors, but is not so often spoken by dividend investors. People wise enough to avoid trying to time the market look at this phrase with a bit of skepticism, and for good reason. Many dividend investors are comfortable holding onto their investments even as they soar in value far above what they are realistically worth because they are mostly focused on the dividend income rather than the stock price.
Take a look at Coca Cola. In the late 1990s, Coca Cola’s stock price soared to incredible highs before crashing back down to reality. During the high, Coke had an astoundingly high P/E, and a dividend yield of under 1% despite paying out a considerable percentage of their profits as dividends.
What I’m not suggesting is that you try to time the market. That’s usually a fool’s errand. What I’m suggesting is that you keep tabs on the fundamental value of your stocks, and if they have grown in price to a level far beyond what you would be willing to pay today, then it may be wise to sell if you can find a better deal to put your money into. Taxes should be taken into account for the decision.
If, for example, you purchase a stock for $30 that pays $1 in dividends this year, then the calculated dividend yield of this investment is 3.33%. If, in 10 years, the profits and dividend have only increased by an average of 10% annually, but the stock price has increased by an average of 20% annually, then the stock value will be worth over $185 and it will be paying out about $2.60 in dividends that year. This is calculated to be a dividend yield of only about 1.40%. If the investor concludes that his purchase is now over-valued, he or she can sell this company and purchase perhaps a different investment that currently yields 3.33% along with considerable growth opportunities like his original investment once did. If he does this, his $185 (taxed down to perhaps $150) with a 3.33% dividend yield will give him $5.00 in dividends per year instead of $2.60. This makes a huge difference if you have a large number of shares.
I wouldn’t recommend selling due to overpricing, however, unless the stock price is significantly out of proportion with what you consider its value to be, or if the difference between the expected rate of return of the current overpriced investment is considerably less than a target investment idea, even after taking fees and taxes into account.
Parting is such sweet sorrow…
As long-term investors, and not short-term traders or speculators, many of us really do look at our portfolio as a list of companies we own. That is, of course, what a share is- a share of ownership in a company. While selling stock might be easy for someone who doesn’t look at it this way (and indeed, many people simply look at stocks as simply pieces of paper that fluctuate in value), it can be difficult for someone who has a more fundamental view of investing and holding. While we’d like all of our investment choices to be perfect ones, where our holding period is “forever” as one famous investor would say, some of them will inevitably not be.
All in all, I do think it’s better to be someone who has a tendency to continue to hold stocks when it is no longer appropriate to do so, than to be someone who doesn’t hold onto their stocks for as long as they should and is far too quick to sell under a variety of scenarios. Nonetheless, it makes sense to periodically review your investments to ensure that they still make sense.
Hello Matt, love the Site. I have a question: if you purchase a stock when its yield is 3.33% then the stock appreciates and the yield becomes 2%, if your cost basis doesn’t change isn’t “your” yield still 3.33% ? Is it wrong to think in those terms?
Thanks!
Hey, these are good points. Sometimes, I’ve sold due to being way overvalued, and then later bought the shares back when the price dropped a lot. The overvalued sale is a tough one — if that’s the only reason for the sale. In that case, I will sell if I’m watching a stock that has better prospects.
Marc,
I’ve been considering writing an article about yield on cost that discusses that very sort of question. My short answer is that looking at your current yield based on what you once invested is one good way to view how well your historical investing performance has been, but it’s not a good reason to determine future behavior.
Let’s take my example in the thread. First, you buy a share for $30 with a $1 dividend, which is a 3.33% yield. Years later, the share happens to be worth $185 and the dividend is $2.60,which is a 1.40% yield. But, the $2.60 is an 8.67% yield on the original $30. Nonetheless, you decide to sell this share because of how overvalued you perceive it to be, and after taxes, let’s say you have $140. You then purchase a stock with a 3.33% yield, which gives you $4.66 in dividends. This $4.66 is a 15.5% yield on your original $30, so it’s even better.
Larry,
The overvalued sale is definitely tough. I generally advise only selling for this reason if the stock is really overvalued. If one sets their “overvalued” threshold too low and sells for this reason too often, constantly getting in and out of positions, they’re going to lose tons of money to fees and taxes and they might be more and more inclined to try to time the market which is a bad bet.
My rules of thumb are that:
-The stock must be very overvalued, not just somewhat overvalued. I continue holding onto companies I view as somewhat overvalued if I still think it’s a great company for the long-term.
-I must have a perceived better place for my money after I sell.
-I must take taxes into account for my sale, and still find this new place for my money to be desirable even though I’ll have less money to invest after taxes.
-I must provide myself with a significant margin of error. If I’m going through the hassle of selling and taxes, I must be quite confident that this new place for my money is better than where it is now. It doesn’t make sense to do all of this just to break even- it has to look like a very considerable improvement over the current place of the money.
Matt,
Never thought in those terms before when considering yield.
Thank you for the new perspective.
Marc
Nice post. I started doing dividend investing over a year ago and I have one investment that double since I bought. The yield has significantly changed at the current valuation. Selling has cross my mind for reason 3 but not because the price is over valued but because I got it at a bargain price. I bought a Canadian bank during the market melt down at 50% the current price. They have been paying dividends for over 100 years with regular and consistent growth. The dividend growth is a key component of buying dividend paying companies for me and selling it feels like I am going against my rule … I continue to hold at the moment since as my core holding in the finance sector.
Passive,
I of course don’t make direct investment recommendations to individuals, but in my investing view, I don’t sell good companies that are not overvalued.
Thanks for the comment.
THANK YOU for posting this! I really like your blog!!
Steve
Common Cents
http://www.commoncts.blogspot.com
I agree that a company that cuts its dividend deserves to be sold. I’m not the kind of person to wait for that to happen. I am a “value” dividend investor meaning I love investing in undervalued dividend stocks. However, I’m not a buy-and-hold type of guy. I think there’s a lot of merit to watching what other investors think about the stocks in my portfolio, and one of those ways is watching the stock’s price in relation to its 200-day moving average. A juicy stock yielding 8% after it falls even 20% will need over 4 years of dividends to make back that lost capital, but not if the company cut’s its dividend! BP is a perfect example of how a trend following strategy “foretold” upcoming events and would have prevented a significant loss well before BP suspended its dividend. You can read about it here http://www.dividend-investing-lighthouse.com/trend_following.html (click on the “unfortunate example” link).
It does not matter what you bought the action, its not like you can sell at that price if you do not want the stock more. You must sell at market price. If the price drops HD compared to the initial amount of 60 for a lower price, so you get a lower return on your (bad) investment indicates that the actual price. But if you must sell your shares and reinvest in new shares at 2.9% more, you can always see exactly the same because it would yield a higher return on initial investment much lower.
What about selling when the dividend stock isn’t keeping up with the S&P 500, even including dividends?
Hi Kevin, thanks for the comment.
In my view, the answer to that question would be based 100% on the reasons for the underlying under-performance.
-Is the company doing well, but the stock lagging behind? If that’s the case, I’d check if the company is undervalued, and if so, I’d be far more interested in buying than selling.
-Is the company experiencing slow growth? If so, I’d try to conclude whether this is due to a short term headwind, or due to a long term business model problem. If it’s former, I’d generally not sell. If it’s the second, it means revisiting my investment thesis, and if I conclude my investing thesis is in error, I’d consider selling.
So basically, poor stock performance generally either is not an indicator to sell, or it’s coupled with a fundamental reason to sell, such as one of the reasons on this list. It’s not a reason in-and-of-itself to sell, in my view.