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Dividend Cuts: Time to Sell?

by: Dividends4Life October 15, 2008 | about stocks: BAC / SFI / WB / WM    

Dividends4Life

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I am not a stock trader; I am a dividend and value based long-term buy-and-hold investor. When I add a stock to my dividend portfolio, it is my intention to hold the stock forever. I am not smart enough to time the daily gyrations of the stock market. When stock prices start dropping, our primal instinct of flight kicks in and we want to sell. In many cases that is the time to be buying. However, sometimes selling a stock is the right thing to do.

In determining when to sell a dividend stock, I have one hard and fast rule: When an individual stock held as a dividend investment lowers its dividend, immediately sell it. This may seem like a stringent rule and I have taken a lot of criticism for it from both directions.

Some have said waiting until a stock drops its dividend is too late. There were rumors and innuendos that Bank of America was going to drop its dividend some time before it was announced. As it turns out, the rumors were correct this time. However, I can't (and won't) base investment decisions on innuendo or rumor.

Others have said that selling a stock after it cuts its dividend is too early. Their argument is the bad news has already been priced into the stock and you are selling into weakness. I feel strongly that an immediate sell is the correct thing to do for the following reasons:

I. Cockroach Theory

When a company that has a long history of raising dividends and suddenly stops, it is usually more than a simple bump in the road. For the one cockroach you have seen (lower dividend) there are probably hundreds waiting to reveal themselves.

II. Adultery Theory

I view a dividend cut as financial infidelity by the company. After a company has raised its dividend 10, 20, 30 or more years that first dividend cut is very hard. Like someone who first has a series of affairs after 30 years of marriage, the first one is guilt ridden, but it is much easier the second time around. Eventually, the guilt goes away. Do you think Citigroup (C) would have the same difficulty cutting its dividend again? In the case of C, I sold part of my position when it became evident that its capital structure could not sustain the company going forward without a substantial cash infusion.

III. Experience

My experience has been once a company cuts its dividend, the stock continues to drop. The following stocks, which I sold after a dividend cut (prices as of 10/13/08) are examples of this:

  • Washington Mutual Inc. (WM) - Sold at $18.11 on 12/11/2007; it's now worthless.
  • Wachovia Corporation (WB) - Sold at $25.89 on 4/15/2008; it's now trading at $5.85.
  • iStar Financial Inc. (SFI) - Sold at $2.32 on 10/3/2008; it's now trading at $1.46.
  • Bank of America Corporation (BAC) - Sold at $28.51 on 10/7/2008; it's now trading at $22.79.

Sure BAC will likely come back over time, but WM and WB will never come back. Even assuming BAC will come back at some point in the future, I likely would have been better to sell, wait for the 30-day wash sale window to clear and buy it back (see IV below on why this is not an option for me.)

IV. Portfolio Goals

The most important reason for selling a dividend stock after it cuts its dividend is that the investment is no longer aligned with my dividend portfolio's goal of building an ever-increasing source of dividend income. Some have argued that certain securities are good value plays after a dividend cut. This may or may not be true, but my dividend portfolio's primary objective is dividend income, not capital gains. I have a separate portfolio for that. To date, I have not transferred any dividend stocks to my capital appreciation portfolio.

Finally, some will say that it was the "right" thing to do for the company to cut the dividend given the circumstances. In many cases, I do not disagree. However, in the cases I have been involved with the company was not "given" the circumstances; they created them through their own actions. If a company was truly a victim of circumstances, which couldn't possibly be foreseen or planned for, I would gladly cut them some slack and consider an exception to my rule. This situation rarely ever comes along.

Disclosure: No position in any of the aforementioned securities.

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This article has 13 comments:

  •  
    Oct 15 06:21 AM
    Clear, concise and short. Excellent article, great thesis, thanks for contributing, we are all the wiser.
    Reply
  •  
    Oct 15 07:40 AM
    Tough call on when to sell. Clearly you were smart with disposing of all those stocks, but what if you hadn't? I would think that as a dividend investor you would sell a stock on principle after a dividend cut and if over the long-term the company again began to increase it look at re-initiating a position at that point.
    Reply
  •  
    Oct 15 08:54 AM
    One of the strongest, most sensible statements I feel is; My experience has been once a company cuts its dividend, the stock continues to drop. After all, this goes to the whole screening process in buying a dividend stock in the first place as when I search for a possible dividend buy, part of the criteria from the start is that their dividend has consistently gone up every year, for example PG. I will add however, given the drastically new landscape of the investment world it may require more patience to find such candidates in the immediate future.
    Reply
  •  
    Oct 15 10:44 AM
    Retired now 13 years. Your dividend stock philosophy is exactly the same as mine right down to the infidelity emotions that follows a cut. My greatest successes have been with MLP's and BDC's-last week was truly a gift from heaven for us "divi" fans. B of A has now given up the Dividend Aristocrat crown-we now start the clock rolling on another 25 years.
    Reply
  •  
    Oct 15 11:00 AM
    Excellent article. I wonder if the author sold GE, if he owned it, when they announced they will stop raising their dividend.
    Reply
  •  
    Oct 15 11:31 AM
    I pretty much agree with this philosophy, however, I never seem to get it right on the sell part. The stock seems to sink quicker than my reaction time. I lost some on IMH and it was below where I wanted it before I even noticed. I therefore still hold this almost worthless stock. I've made a lot of money using the model in this article.
    Reply
  •  
    Oct 15 11:58 AM
    The article is good but external events change the thought process. Now that the government is making loans to the banks, we have to rethink the order of things. A set rule will not cut it. By the way BAC is at $25.64.
    Reply
  •  
    Oct 15 12:15 PM
    You have a good point since you are a "dividend Investor" it makes sense to sell when the dividend is cut. I say stick with your game plan. Everyone has a different reason for investing be it dividends, long term expectations of investment growth or short term speculation. Me, I like good dividends and feel something is wrong when a company has to cut it, makes me nervous too. Time to re-research the company & make a decision based on any new info discovered.
    Reply
  •  
    Oct 15 05:49 PM
    I respect how you set a system for yourself and follow it through. Though I must also point out that investing through searching out for companies with high dividend yield is a dangerous stategy in the first place, and given the industry wide turmoil, shopping in the financial sector is akin to swim with the sharks. I'm unsure what the qualifications are to become an article contributor on Seekingalpha, but the amount of articles with unsoliciated buy/sell advices amazes me. when you have someone(not mentioning names) post an article here singing praises of WB, C and WM earlier in the year with statements like "Anytime WB below $40 is a buy", I wonder how much damage it contributes to the individual investors community.

    In beginning of this anyone with a decent knowledge of financial history should've realized that Majority of the financial institutions won't survive this, yet the small number of firms that survive will dominate for the next decade and more. It wasn't hard to see even a year ago that WB and WM won't and BAC will.

    Good luck!
    Reply
  •  
    Oct 19 01:35 AM
    Seems more like he's bragging about "great sells." Due diligence reveals these things beforehand. I bet he sold all of these at a loss, while paying taxes on the dividends along the way.

    Doing your homework is much better than any "sell when [blank]" system ever will be. The reference to buying BAC back after 30 days, while it probably will be a good trade, is just that - a trade. A lower stock price allows you to average down.

    Also, I wouldn't count SFI out for a turn-around. Maybe they weren't wrong about buying distressed debt, just early.
    Reply
  •  
    Oct 20 03:29 PM
    I am not sure what the author is trying to say in this article. If the author is saying that as a long term buy and hold investor that you should sell after a company has cut its dividend then I could not disagree more. In all of the stocks that are listed in the article, there was an avalanche of information that indicated the companies had serious problems long before they cut their dividends. In each of the cases selling at the time indicated was like trying to close the barn door after every living creature that had resided in the barn had already left and had been gone for weeks. It is imperative to do your homework.
    Reply
  •  
    Oct 22 12:11 AM
    How about comparing apples to apples!
    Reply
  •  
    Oct 22 02:50 PM
    As isherlock has indicated, I, too, am unsure what the qualifications are to become an article contributor on Seekingalpha, but the amount of articles with unsoliciated buy/sell advices amazes me.

    The following is one article written a few weeks before WaMu was stolen by FDIC and given to JP Morgan for almost nothing (1.9 billions) - leaving the shareholders with nothing:
    WaMu: Intensification of Stealth Buying
    by: R.J. Chopin August 13, 2008 | about stocks: WM
    R.J. Chopin
    In Your Watchlist
    About this author:

    back to yahoo finance add to my yahoo back to cake

    Stealth buying intensifies as 54 new institutional investors quietly acquire shares of Washington Mutual (WM), according to NASDAQ Detailed Institutional Holdings. That’s an astounding 567 institutional investors now holding 52% of the company. Toscafund Asset Management LLP, a British based value player, reportedly snatched up 105.5 million shares, or a 6% interest. Spotting stealth activity requires painstaking analysis. The majority of investors fail to recognize stealth activity until it’s publicly disclosed. The wholesale accumulation of WaMu shares trumpets a clear “Buy Signal.”

    WaMu used this past quarter to come clean, cleanse the books, or as Howard Shapiro of Fox-Pitt Kellton put it, “move ahead of the curve on credit, having charged off or provided for 65 % of it expected loss exposure.” WaMu added over 17 billion dollars of fresh capital, enhancing the balance sheet with 50 billion dollars of liquidity. This was not done out of necessity, but more in a sense to silence the mouths of its adversaries that are mostly short sellers that traffic in fear, terror, false rumors, and manipulation.

    WaMu’s house keeping has positioned the company to report better than expected results in the next quarter. This will no doubt come as an overwhelming surprise to those that have been seduced by short sellers, but nevertheless, it’s going to be an eventful day. To say that short sellers will be caught unaware is understating the reality of a panic short-cover rally.

    The undeniable facts are plain to see. The intensification of stealth buying will only continue. Short sellers can and will lie about
    Reply
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