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I use an investment code as a tool to help me manage my portfolio. It is something that I recommend all investors do as it helps manage emotions. It is much harder to make an emotional decision if you have certain rules of portfolio management that you are committed to following. For this blog, I put pen to paper (so to speak) and wrote them down as part of The Dividend Guy’s Investment Process series (see my sidebar to the right). I believe this investment code should be consistent during think and thin, however I also believe that there are times to update it based on learnings and market experiences. If there are more sound investment principles to live by than the ones I have chosen, then I want to ensure that I am using those.
This recent market changes and dividend cuts has got me thinking about my dividend growth strategy. In my original dividend code I had the phrase “Never Sell” as part of the list. I also included the following: “Hold dividend growth stocks that consisitently raise dividends to my core portfolio“. These are actually contradictory statements as I cannot achieve both without violating one or the other. If a company cuts its dividend then that definitely is in contradiction to the dividend growth code. However, based on my principles I can never sell. Stalemate! I therefore have initiated a change to my principles that I would like to receive your feedback on.
The changes I have made are as follows:
Instead of:
Hold dividend growth stocks that consisitently raise dividends to my core portfolio
Use the following Investment Code:
Generate a reliable and growing stream of income from dividend stocks
and
Instead of:
Never Sell
Use the following Investment Code:
If a company cuts its dividend, then immediately sell that stock and move money to another dividend growth stock (according to asset allocation)
The obvious risks with this strategy are that the stocks I sell because of the dividend cuts will rise in price in the future as the company recovers and become a dividend growth stock once again. However, there is no way to predict the future and we need to act on information we have. A company that cuts its dividend is not being managed well and I do not want that stock in my portfolio. I anticipate that the returns I will receive from a better company will far outshine any potential gains on the dividend cut company.
So there you have it, my evolving strategy to build a solid and growing portfolio. Let me know what you think!
I think it is a great change! If the stock is not holding up its end of the bargain (paying and increasing dividends) it doesn’t belong in our portfolios.
Best Wishes,
D4L
Personally I do not like the idea of indiscriminantly selling any stock that cuts its dividend for several reasons:
1. You are selling the stock at the worst possible time (into weakness). This is similar to buying high and selling low.
2. It is too hard and fast a rule. Every situation is different and cutting the dividend might breed other opportunities or be a necessity for a company that will excel in the future.
3. Dividends are great but they are not my sole reason for investing in companies.
In the case of Bank of America, this is one in 100 year crisis and BAC is coming out as one of the winners here. They’ll gain market share and have a more strength and diversity now due to CFC and MER.
Using this reasoning you should probably sell any company that doesn’t raise it’s dividend too as this is not ‘dividend growth’ and could be a precursor to a cut. At least this way you might be able to get a reasonable value for the stock upon selling it.
I think The Money Gardener’s opinion is in the minority here. Unfortunately I have to agree with D4L and TDG on selling the dividend cuts issue. My research shows that dividend cutters tend to underperform dividend initiators and growers over time. But don’t take my word for it check this out ( i know external links, shameless self promotion)
http://www.dividendgrowthinvestor.com/2008/06/when-to-sell-your-dividend-stocks-part.html
In addition to that, most of this years dividend cutters have also gone under several months after their dividend cut announcements.
http://www.dividendgrowthinvestor.com/2008/09/which-bank-will-be-next-follow-dividend.html
In response to moneygardener, one would sell GE, because it recently chose not to raise its dividend for the 1st time in years. On the other hand, I believe that GE is a buy, because once this crisis passes, it will once again continue raising its dividend, assuming that the crisis doesn’t seriously affect its financial division. I feel that one has to think about this new approach on an individual company basis, but I do like the change in the investment code to reflect our new investment reality. I should have sold a # of financial stocks earlier if I had followed this new approach towards investment.
I think the specifics aren’t as important as an investors ability to critically examine their activities and decide on whether they need improvement or can be re-evaluated in order to better position an investor for success. I do this on multiple levels and I expect that my investing approach will continue to change over the next 20 years or so.
I don’t encourage investors to change their approach drastically or frequently, but just as you re-evaluate your investments through re-balancing each year an investor should be taking stock in their own success/failures in order to better understand where mistakes are occurring or how to best protect themselves from risk.
Thanks for the humble post
Hi Dividend Guy,
I have a couple of comments on the changes to your code.
First, congratulations on changing the code in response to new knowledge and
experience. In my own investing, I use the term “constitutional document” to refer to what you call your code. In my book “Sensible Stock Investing,” I recommend reviewing your constitutional documents once per year, or when conditions warrant, to verify them or to make appropriate changes.
That’s what you are doing, so congratulations on taking this intelligent
approach.
In regard to your specific changes:
(1) I don’t see a whole lot of difference between the statement you are deleting
and the one you are replacing it with. The new one (“Generate a reliable and growing stream of income from dividend stocks”) reads a little more clearly,
but I don’t see much difference in meaning. Perhaps I am missing the point of
the change.
(2) I agree with changing “never sell” to an approach that gives you more
flexibility. For comparison, refer to the “code” for my public Dividend Portfolio.
(The code is on this specific page:
http://www.sensiblestocks.com/dividendportfoliostrategy.html ). I include
several reasons for selling, including if a company cuts its dividend (same as
you), but also if a single stock becomes too large a position in the whole
portfolio (I don’t want to lose diversification benefits), and also if I see an
opportunity to swap a dividend stock for a better one.
As recommended in an earlier post, I am considering modifying the “Sell any stock that cuts its dividend” rule to a more flexible one that examines the reasons behind the cut.
Anyway, I think you’re on the right track.
Dave
Hey guys – thanks for all the good comments. I figured this one would generate some debate.
MG, this is something I struggled with a lot. However, after seeing similar research to DGI’s post I decided that my money could be allocated better. His statement from his post really sums this up – “…dividend cutters as well as non-dividend payers underperformed dividend growers by about 5% on average per annum from 1972- 2005”.
Milton Datnoff – you are right that an issue with a dividend cut sell strategy is what to do with a company that has increased dividends for many years suddenly decides to not increase the dividends (a la GE). I am still putting some thought to this and would like to hear other people’s opinions. What if you buy a stock because of dividend growth and then the growth stops happening?
Dave, thanks for your comments. I like your point about selling a stock if it holds too much influence over your portfolio because of prior growth.
Thanks again to all commenters!
If I can chime in with my humble opinion……
As much as I think BAC will be stronger than ever in the future once this mess is all cleaned up, I purchased this stock for it’s increasing dividend. The stock no longer providing me with what I bought it for…….SOLD. I will look at BAC in ten years, provided it reached Mergent’s acheiver status.
As for GE, yes it is true they did not raise the dividend this year, but they increase usually in Jan of the next year, so they still could raise in 09.
Actually they can raise anytime in 09 and they will still show an increase to the total dividend in 09 when compared to the amount paid in 08.
Home depot is in the same boat.
Even if GE’s dividend stays the same in 09 I will not sell.
Lowell Miller (The Single Best Investment..basically my investment framework) says that he : “will generally not hold an investment for more than 2 years without a dividend increase”.
He also says there must be a damn good reason for no increase. I believe this whole year to be an extraordinary event.
So in a nutshell, dividend cut = sell, and no increase = “let’s give it one more year”, provided there is a damn good reason for no increase.
Research that shows that dividend cutters and non dividend payers underperform the market is expected as this will include the numerous companies that cut their dividend because they are crappy business to begin with, or became crappy businesses, and maybe they were never dividend growers to begin with.
It all comes down to how you feel about the company and the environment. In BAC’s situation I believe they will be the exception to the normal dividend cutter, rather than the rule.
MG,
Of course there are exceptions to the rule and most probably BAC will emerge from this mess. The issue however is that the company issued so much more common and prefferred stock that obtaining the dividend achiever status would be harder than before..
As for exceptions, I would say con EDison and electric utility in US, cut their dividends in 1970’s only to achieve a very good total returns and a dividend aristocrat status for over 3 decades now..
But as a rule large cap stocks that cut their dividends are not very nice to own.. GM is one example that comes to mind.. Bethlehem Steel is another example from the 1980’s…
I have somewhat wider window, something similar like MG. I maintain two portfolios viz., dividend portfolio (for cash flow) and value portfolio (for capital appreciation). Dividend cutters are absolutely “no” in dividend portfolio (Same as many of us dividend investors). But to sell them (or buy new) depends upon the value preposition. While making decision, one of the key issue that I always struggle with is how to balance dividend growth with capital loss/appreciation.
e.g. I bought C four years ago and was good dividend growth stock. I received dividends for four years. When it cut the dividend, the total price was below my cost basis. Does it make sense to sell at loss after four years? Every company will struggle at some point in time! That’s when I look at value preposition and decide next step. Consider the case for BAC, C, and GE. I believe BAC has value preposition and hence, bought few more and moved it to value portfolio. C was sold and did not deserve a place in either of the two portfolios. I have held GE for last 6 six years. So far it has met dividend growth requirement. But its capital value has been going down. It has now frozen the dividend until 2009, and future dividend growth can be questioned (very high debt – they will need more cash flow to service it). So although GE may not be dividend growth sock, it may be a value play.
Nice discussion here and good to read the diverse viewpoints.