We are seeing a lot more dividend decreases in the most recent past (see matisse’s post). Both large and small firms (primarily financial) are decreasing their dividend payments to investors to manage their financial performance. For an investor like me who searches for and attempts to invest in only those companies that continually increase their dividends, it certainly reduces the pool of possible investments. In addition, I currently own Citigroup which has recently slashed its dividend and there is also some risk that Bank of America will do the same. I believe that most tried and true dividend investors sell these companies immediately. One of my investment principles is to never sell, so I have been holding. That being said, I have come up with 3 possible actions that an investor can take in light of a dividend decrease. Your job will be to figure out which one you want to apply to your own portfolio.
#1 Sell the Stock Immediately
The easiest and simplest action to take upon a dividend decrease is to immediately sell that stock. This is a powerful rule because it takes all the emotion out of the decision. I tried to find some research that talked about the effects of a dividend drop on stock price, but was unsuccessful. However, I did find one study that concluded that a dividend decrease, “…generally occurs at the low point of a firm’s financial decline and marks the beginning of firm restructuring activities.” In other words it may be the lowest of the low.
#2 Hold the Stock and Buy More
The flip side of selling a dividend stock that lowers its dividend is to hold it and actually buy more. This is directly related to the study I mentioned above, in that it may be the lowest point for a company that needs to drop its dividend and that future restructuring may have positive implications on the performance of the company. With this strategy it is crucial that the investor understands as much about the company as possible. This is a riskier strategy and you will need to be sure that the potential return will offset the additional investment risk.
#3 Hold the Stock and Do Nothing
This is the status quo option. You simply do not take any action as a result of the dividend cut – either buying or selling. It is a kind of wait and see action. This is the action that I tend to take. I am still holding onto Citigroup and my primary reason is that I have a real aversion to selling a stock because I have been burned in the past. For example, when Merck was having all of its lawsuits for Vioxx and did not increase the dividend I sold. The stock continued to show strong share price performance and I lost out on a good return. My investment outlook is 20+ years and I feel I have time for Citigroup to work its problems out and will continue to be the great company it once was.
The most important aspect of #3 however is that just because it is a status quo, it does not mean that an investor can take their eye off of the fundamentals. If sales, EPS, debt, etc continue year after year to show poor performance then decisions will still need to be made. However, I do realize that all companies are going to go through a rough patch from time to time and patience is important.
(Photo Credit: rore_d)Google+