3 Possible Actions to Take with a Dividend Decrease
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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)
20 Comments on this post
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Adam said:
Is is possible to have any more advertisements on this page? Wow!
Stumbled across your blog and although it looks good (content wise) – I can’t get over the amount of advertisements and annoying ContentLinks.
Ah well…
June 25th, 2008 at 8:20 am -
Ben Moreno said:
I would most likely sell the stock if the dividend decreased. I like to buy dividend companies that will most likely never decrease their dividend and when the price falls, hold and buy more.
For example, (WMT) Walmart and (JNJ) Johnson & Johnson.
These two have increased their dividends many many years in a row and produce huge amounts of cash flow.
In likes to the previous comment, I don’t think you have too many ads on your page. I like your theme. I know you probably work hard in your research and blogging, that is why the ads are necessary to get paid for the hard work you do.
June 25th, 2008 at 11:14 am -
Dividends4Life said:
Great read! I definitely fall under #1.
Best Wishes,
D4LJune 25th, 2008 at 11:42 am -
moneygardener said:
Great post! I don’t mind all your ads at all!
June 25th, 2008 at 7:29 pm -
Cash Canuck said:
I think it’s necessary to analyze this on a case-by-case scenario. Do the fundamentals support selling the stock, or has the company lost the ability to generate cash flow? The earnings of Merck during the Vioxx fiasco remained buoyant due to their stable of other products. The subsequent reactionary price-drop was a great opportunity.
Keep in mind Citigroup still maintains one of the largest networks of consumer banks in the US. Their lower price may tempt takeovers from abroad and within the states, which can be lucrative. IIf I held Citigroup (which I don’t), I would keep re-investing my dividends via a DRIP (option #4?). The stock is still yielding 6.8%, what more could you ask for?
What motivates you to “Never Sell”? If a company stops making money due to factors aside from a major one-time writedown, then they won’t be able to support their dividend. For the record I consider the ABCP a “fiasco” like the Vioxx episode, except it hit the entire industry, not just one company, anways I ramble. Love the site, keep ‘em coming!
June 25th, 2008 at 9:08 pm -
Dividend Growth Investor said:
Well, I think just like TDG and my holding period is “forever” by default. The only way that I am going to sell is if the dividend is cut completely to 0. I did some research and posted it in my blog if you are interested:
http://dividendgrowth.blogspot.com/2008/06/when-to-sell-your-dividend-stocks-part.html ( check part 1 as well)On one hand we have research showing that dividend cutters and non-payers have underperformed the markets on average. On the other hand we have research showing that holding a diversified portfolio of stocks across all industries tends to outperform the market if you do not add/subtract stocks from it.
I also think that selling your stock just when the dividend cut is announced is suicidal, since every dividend investor who has been holding on to their dividend stock is going to sell and sell at all price ( a sign of a bottom). In addition, what happens if the company increases its dividend one-two years after the cut? Check the dividend history of ED. It did cut its dividends in 1970’s, only to increase them for the next 3 decades.
Hasn’t academic theory shown that active portfolio management does not lead to superior returns? It has to me. The less active you are as an investor, the better off you’ll be in the long run. ( assuming you have a sound plan, properly diversified mix with large, mid, small cap domestic and international stocks, reits and fixed income).
June 26th, 2008 at 6:59 am -
MBL said:
What about selling some of the share since you made a profit through gains and reinvestment?
All three options are valid but it seems like you didn’t offer a fourth, where you sell the difference between the amount you originally invested and the amount you made since.
June 26th, 2008 at 4:15 pm -
Dividend Growth Investor said:
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June 28th, 2008 at 8:17 am
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