Thursday, April 18, 2013

The right time to sell dividend stocks

With the market hitting fresh 17 month highs, investors have to look hard in order to find attractively valued opportunities. Plenty of stocks such as Aflac (AFL), Emerson Electric (EMR), 3M (MMM) and Realty Income (O) ,which in early 2009 rewarded enterprising dividend investors with their highest yields in a decade, are now yielding much less. Many stocks are also trading at rich valuations, which suggests that investors these days are willing to pay a premium for future growth.

The rapid increase in prices since March 2009 lows has many dividend investors wondering whether they should lock in some or all of their gains today. Investors who were able to purchase stocks in 2008 and 2009 might be sitting at gains, which seem equal to the dividend payments they could expect from a stock for several years to come. The issue with this thinking is that dividends typically increase over time on average while cash in the bank typically loses its purchasing power over time. As a result the investor who takes profits today might lose on any increases in dividends as well as on any future price gains. They would also have to find a decent vehicle to park their cash, which is getting harder and harder to find these days.

Because of the reasons stated above I would not consider selling even if my position went up 1000%. It would not be a wise idea to sell a stock which was purchased as a long term holding and its business hasn’t changed much. What is important is that the original yield on cost that has been locked with the purchase in 2008 or 2009 is there to stay, as long as the dividend is at least maintained. I would only consider selling when the dividend is cut. If a stock you purchased had a current yield of 8%, your yield on cost of is 8%. The nice part about this is that you keep receiving 8% on your original cost as long as the dividend is maintained. Then it doesn't really matter if the stock is currently yielding 1% or 2% - you still earn 8% on your cost. If the dividend payment is increased then your yield on cost rises as well. Companies like Johnson & Johnson (JNJ) or Abbott Labs (ABT) for example have low current yields of 3%, but their growing dividend payments produce substantial yields on cost over time.

If you were thinking of selling a stock which generates great yield on cost, you should remember that currently the market is overvalued. But the market could keep getting overvalued for a far longer period than you or I could remain sane. Retirees need income, and in the current low interest environment dividend stocks seem to be the perfect vehicle for an inflation adjusted source of income in retirement.

Back in the late 1980s Procter & Gamble (PG) yielded less than 3% for the first time in decades, which was much lower than the 4% average yield that investors received in the mid 1980s. In early 1991 the stock traded at 10.50, yielded 2.40%, and paid 6.25 cents/quarter. Although bonds yielded at least three times what P&G yielded at the time, they couldn’t provide rising income payments and the possibility for high capital gains as well. By early 1994 Procter & Gamble stock increased to $14, after a 2 to 1 stock split, paid 8.25 cents/quarter and yielded 2.20%. In early 1999 Procter & Gamble traded at $46.50 and had split 2:1 in 1997. The company paid out 14.25 cents/share but yielded only 1.30%. The yield on cost for the early 1991 investor was a more comfortable 5.50%. Fast forward to 2010 and Procter & Gamble is trading close to $64 and yielding 2.80%. The yield on cost on the original 1991 purchase is 16.80%. This example goes on to show that selling Procter & Gamble (PG) when it became overvalued, was not a very good idea, because the company kept generating higher earnings and kept increasing its dividend payment. While investors could have found other stocks to reinvest Procter & Gamble (PG) dividends or allocate any new cash, they would have been well off simply holding on to Procter & Gamble (PG) and other dividend raisers despite them being overvalued for extended periods of time.

Right now Procter & Gamble (PG) looks like it could again stay below 3% for the foreseeable future. This time I am planning on adding to my position around $59 ,even though it is not exactly trading at a 3% yield.

Full Disclosure: Long ABT, AFL, EMR, JNJ, MMM, O, PG

Note to Readers: This article was originally published on March 24, 2010. The basic ideas behind it however are still valid, three years later.

Relevant Articles:

- Is now the time to sell your dividend stocks?
- The right time to buy dividend stocks
- Best Dividends Stocks for the Long Run
- Dividend Investors are getting paid for waiting

11 comments:

  1. Also , selling stocks entails tax consequences which can reduce return.

    ReplyDelete
  2. I purchase dividend stocks for a growing income. So long as that is the case, then I remain an owner.

    ReplyDelete
  3. I consider my dividend growth stocks to be global cash machines that stay ahead of inflation. As long as the underlying businesses remain solid and continue to pay a rising stream of dividends, I will maintain my investments in the companies.

    My heirs can deal with Mr. Market if they don't like the investment choices I've made.

    ReplyDelete
  4. Sell or not to sell, that is the question. Take for example my APU purchased 10-18-08 at 29.90, currently up 37%. The yield on cost is 8.75%. (current yield=6.69%). Long term gain equates to almost 5 years of dividends. Yet as you mention, dividends do go up. APU was paying .64 now paying .67 for about 4.5% increase in yield.

    I'm retired, all funds are in my IRA, depend on income for living! Some examples of my income stocks
    CIM, CMO, CPNO, DPM, DPO, EPD, FTR, GLAD, HTS, IWA, JTP, KMP, MAAPH,MMLP, MWE, NGLS, OKS, NYMT, PFD, PNCPL, RGNC, WCO, WIN.

    These probably aren't ones you would consider, but they have been great the past year or so.....it's the future I sweat.

    ReplyDelete
  5. I have been very happy with AINV, Apollo Investments.
    Do you have any opinion on it?

    ReplyDelete
  6. You wouldn't sell an investment that has gone up 1000%? I understand you're a buy and hold guy, but really?

    ReplyDelete
  7. Since I have about $150,000 long term losses from several years ago, I am considering taking some gains and immediately buying back the same number of shares. I am doing this so that my heirs are do not have large tax bill because the losses are forever gone when I die.

    ReplyDelete
  8. Sell when they cut the dividend. I suggest you do some homework on where most of these stocks trade when they announce a cut in the dividend. At the bottom.

    And if a stock advanced 1000% then sell it. Spend the gain and never look back at the dividend. That gain would likely represent more dividends than paid over 50-60 years, at least.

    ReplyDelete
  9. I see you reprinted the comments from 2010 also. I would hope these individuals became a little more realistic in the ensuing 3 years.

    Meantime DGI, keep up the good work, really enjoy your posts.

    ReplyDelete
  10. Hey DGI,

    Thanks for reposting this. Also, what software do you use to track your dividend growth?

    -Zach

    ReplyDelete
  11. @Zach - I'm not sure what he uses but I have a pretty good write up about how to properly calculate the DG rate for your entire portfolio. It's kind of a pain since you have to update the dividends paid, but it's a good starting point.

    If you come across a way to automagically pull the dividends or some sort of free program to track pass that on.

    http://www.passive-income-pursuit.com/2013/01/determining-dividend-growth-rate-of.html

    ReplyDelete

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