Wednesday, October 6, 2010

Dividend investing timeframes- what's your holding period?

One of the most common issues that dividend investors face is the holding period for their dividend stocks. It seems that dividend investors are divided in two camps on the issue. One of the camps believes in active allocation of capital, where positions are continually adjusted depending on company performance, market performance or relative portfolio weights, to name a few reasons. In an era where it is possible to buy and sell dividend stocks within nanoseconds, holding on for more than a few years seems like eternity to some. The other camp is focused on the long-term holding of dividend stocks. The second camp believes in buy and hold investing, an arcane strategy, which is termed obsolete during bear markets, but is widely praised during bull markets. So what should the holding period of an enterprising dividend investor be?

Smart dividend investors should be able to synthesize the best features of both camps on the subject of buy and hold, in order to determine their optimum holding period. Extreme views such as buy and hold forever or buy and sell for five nanoseconds/years should be avoided. Investors should therefore hold stocks for as long as it makes business sense for them to hold on.
In most cases, it takes time for a position to work in your favor. This is particularly true for dividend growth stocks, where low current yields coupled with strong dividend growth result in substantial yields on cost after several years of patience. Investors who focus on stocks like Procter & Gamble (PG), McDonald’s (MCD) or Johnson & Johnson (JNJ) despite their current yields, could generate sufficient dividend income streams over time. Thus, as long as these companies continue to perform well, by enjoying earnings growth to fuel dividend increases, they should be held and added to on any temporary price weakness. While investors should expect to hold on to their shares theoretically forever, in reality they might have to sell positions if things change. If circumstances do change however, and any of these stocks deteriorates to the extent of cutting dividends, then it should be sold, even if held for less than a few years.

When investors purchase dividend stocks, they should expect to hold on to them forever. As a result, investors should assess the viability of their dividend income stream sources, in order to ensure that they are not focusing on chasing hot ideas today, which might cost them in the future. Many investors chase high yield stocks for current income these days, particularly because in the current low interest environment it is extremely difficult to live off interest. The dangers to this strategy are two- fold. The first danger is that without an understanding of the business, investors might purchase an income producing asset which doesn’t deliver sustainable distributions. Canadian royalty trusts such as Pengrowth (PGH) and Penn West (PWE)are examples of this idea. Most Canroys always seem to deliver high current yields, despite cutting dividend payments to the bone. This is because their stock prices have gone down over the past few years, right after Canada announced that it would be phasing out the structure in 2006. Investors who were short-sighted to only chase high yields for current income without understanding why such high yields were being paid in the first place, should have been better off purchasing long term treasury bonds instead.

The other issue with high yielding stocks such as MLPs, REITs or Utilities, is that when interest rates start rising again they could get out of favor with investors. When interest rates increase, investors would demand higher yields from the above mentioned types of stocks, which would push their prices down. In addition to that, since most of these types of companies grow exclusively by selling more shares ( units) or through additional debt offerings, their cost of capital would be increasing. This might even put current distributions at risk of a cut.

This being said, higher yielding stocks could have a place in your portfolio in order to generate current income until your dividend growth stocks generate high yields on cost.

The types of stocks which should be held forever, until proven otherwise, in a diversified dividend portfolio include:

Johnson & Johnson (JNJ) engages in the research and development, manufacture, and sale of various products in the health care field worldwide. JNJ has been consistently increasing its dividend for 48 consecutive years. Annual dividend payments have increased by an average of 13.40% annually since 2000.(analysis)

McDonald's Corporation (MCD), together with its subsidiaries, operates as a worldwide foodservice retailer. The company is also a dividend aristocrat, which has been consistently increasing its dividends for 33 consecutive years. Annual dividend payments have increased by an average of 28.20% annually since 2000. (analysis)

Abbott Laboratories (ABT) engages in the discovery, development, manufacture, and sale of health care products worldwide. Abbott Laboratories has increased dividends for 38 years in a row. The company has managed to increase its annual dividend by 8.60% on average over the past decade. (analysis)

Colgate-Palmolive Company (CL), together with its subsidiaries, manufactures and markets consumer products worldwide. The company has rewarded shareholders with dividend increases for 47 consecutive years. Annual dividends have increased by 11.80% on average over the past decade. (analysis)

Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. Wal-Mart Stores has consistently increased dividends every year for 36 years. Annual dividends have increased by an average of 18.30 % per annum since 2000. (analysis)

To summarize, my holding period is forever, unless some unseen factor causes me to sell. After the sale I would typically try to allocate the cash to a new or existing position in the same sector, while keeping the income loss to a minimum. What is your holding period?

Full Disclosure: Long JNJ, MCD, ABT, PG, CL and WMT

Relevant Articles:

- A dividend portfolio for the long-term
- Dividend Investing Works in All Markets
- Highest Yielding Dividend Stocks of S&P 500
- Will higher taxes bring dividend stocks down?

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