Dividend stocks have lots of appealing factors, and it’s easy to find reasons to buy. Some stocks have a great dividend yield. Others have a decades-long history of raising dividends once a year. Then there are picks with a modest dividend but great upside potential for shares.
If you’re looking for a reason to buy dividend stocks, there are plenty. But a trickier scenario is knowing when to get out.
So when do you sell a dividend stock? Some dividend investors have a holding period of forever, thinking that all stocks suffer slides or even dividend cuts, so it all works out in the wash when your priority is on the quarterly payout. If that describes you, then the answer to the question of when to sell is simply “never.”
Other dividend investors find quarterly payouts nice, but really secondary to share values. Investors with this mind-set typically set stop-losses or set sell targets because it’s the stock price that matters most. 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.
For those 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. You can sometimes stomach a company that keeps dividends flat for a few years, but if a company is slashing dividends it means that the balance sheet has gotten so bad that it needs to literally take money out of shareholders’ pockets. The most likely scenario in this situation is that investors will be stung twice — once with the cancellation of dividends and again as share prices suffer. Take General Electric (NYSE:GE) in February 2009, for example. When it cut its dividend, GM saw shares drop 10% the next day.
The dividend stock sees its annual dividend yield drop below 1%. There are plenty of stocks out there that offer a nominal dividend — even small-cap companies with lower volume and a comparatively small pool of profits to share. However, if a company’s dividend is below 1%, chances are it’s not a dividend stock. It’s just a stock that happens to offer a dividend. If a stock is truly in your portfolio because of its quarterly payout, you must demand more than a payout of just a few pennies per share. 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 “yield on cost” for the specific stock is below 2%. Let’s say you bought shares of Home Depot (NYSE:HD) in 2000 at their peak of around $60 a share. The current annualized dividend for HD is $1.16 per share — meaning your yield based on the cost you paid is just 1.9% — meanwhile, HD yields 2.3% on 2012 prices around $50 per share. And had you bought in for August 2011 lows around $28, your personal “yield on cost” would be about 3.5%. Just as profits are relative depending when you bought in to a stock, so are dividend yields.
The dividend stock is bought out. Frequently, such deals are made with a lot of cash — meaning there’s less to pay out in dividends. So don’t wait around three months anticipating a payday that won’t be all that impressive in most cases. Other times you might find that a company with a great yield and good potential for shares has been bought by a less favorable competitor, so it’s better to move out of the position instead of accepting the resulting shares from the buyout. Lastly, obviously if the company goes private, there will no longer be shareholders to share in the profits.
Your position in the dividend stock is down 50%. Though small fluctuations in share price are not necessarily a problem for dividend investors, watching a position get hacked in half should set off warning bells. 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. Waiting five decades (if not reinvested) just to get back to square one doesn’t make any sense no matter how healthy the dividend payout is. You’ll be better served by simply taking the haircut and 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 that’s on the rise than a bad stock that’s getting a dead-cat bounce. Think of it this way: If you find a stock with a similar yield that provides the exact same performance, all you’re out is your broker fee. When you’re down more than 50%, even the most conservative buy-and-hold investor should consider rolling the dice.
Jeff Reeves is editor of InvestorPlace.com. As of this writing, he did not own a position in any of the stocks named here. Follow him on Twitter at http://twitter.com/JeffReevesIP.