The next factor to think about is that replacing appreciated shares simply because the yield is low, for a higher yielding security, should take into account past and projected growth in earnings and dividends. An investor should look for growth at reasonable prices, and should not focus solely on the dividend income at all costs, while ignoring capital gains. This is because a company that cannot grow earnings and dividends today, will likely be unable to grow share prices over time. This is important, because your capital is losing purchasing power over time.
In contrast, a company like Becton Dickinson has a growth kick that can result in growing earnings and dividends, which could eventually translate into higher prices. Most equities share a portion of earnings with shareholders in the form of dividends, and then reinvest the rest, in order to grow and maintain the business. A company like Con Edison, which pays out a very high portion of income to shareholders will be unable to grow quickly enough. As a result, its earnings power might not translate into growth in dividends and stock prices, that can maintain purchasing power of your income and capital.
The next factor is that chasing yield for sake of yield is a very very dangerous thing. Most investors who start investing for dividends always seem to be attracted to the highest yielding securities out there. This is a mistake, because they are usually not taking into consideration the sustainability of the dividend payment. Most of these investors do not do a very good homework in understanding the business model of a high yielding company, and are focusing only on the high yield aspect of it. What good is a 16% annual dividend yield, if the dividend payment is cut by 80 or 90% in the next year?
You would have been better off with a company yielding 2 – 3% in the first place, that has the capability and desire grows dividends over time. The issue with selling an appreciated company that still has potential, for a higher yielding one, is a slippery slope in yield chasing. Once you sell start selling the lowest yielding components of your stock portfolio, without accounting for such factors as sustainability, growth, and understanding of the business, you are becoming essentially a yield chasing investor. In reality, yield should be the last factor in your fundamental analysis.
The last factor on selling is mostly a blend between my personal experiences as a dividend investor and academic studies on the performance of individual investors. According to academic studies, individual investors routinely underperform their benchmarks by as much as 9% per year. This is caused by frequent trading in their portfolios. Based on my own experiences, I can vouch to these findings 100%. When I look at some of the sales I have done, most of them have been pretty disastrous. I have essentially managed to sell a stake in a company that was growing well, and might have looked overvalued relative to another company.
However, after a few years, I calculate that I would have been better off simply holding on to the original security, without the hassle of extra taxes, paperwork, commissions and strains on my already filled schedule. When I sell I am usually worse off. I have realized that I would have been better off just doing nothing, and not tinkering with my portfolio. The point is when you reach out for yield you are sacrificing growth potential and altering the risk profile of your portfolio. You should be aware of that, and be ok to accept lower growth and capital gains that could bring more dividend dollars in the future, for the higher immediate dividend income that will produce less in future dividends and capital gains.
All of this doesn’t mean you should never sell a stock. If it is really overvalued, cuts dividends, or if something material changes, you might be better off selling and going someplace else. However, you need to think about some of the factors explained in this article, in your decision making process on selling.
The urge to do something is the thing that will cost you in the long run. If fundamentals are fine, there is decent EPS growth, DPS growth and you still expect it to continue, your job is to sit tight on investment and let the company do the compounding for you. Sitting is the toughest part of investing, especially in an era where you are bombarded with information on investments all the time. Sitting on an investment, and holding for the long term, might after all be the best strategy for ordinary investors.
Full Disclosure: Long BDX, CL, ED, CVX