Fri, 18 Oct 2013
Investors shouldn't focus just on yield, but also on other factors, such as dividend growth rates and company familiarity, when considering selling dividend payers, says DividendInvestor editor Josh Peters.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. When does it make sense to sell a dividend-paying position from your portfolio? I'm here with Josh Peters, editor of Morningstar DividendInvestor and our director of equity income strategy, to take a closer look.
Josh, thanks for joining me today.
Josh Peters: Good to be here, Jeremy.
Glaser: We've spent a fair amount of time talking about the best way to buy dividend-paying securities, but how do you think about the best way to exit one of these positions?
Peters: You're right. Selling doesn't get as much attention, but it probably should get twice as much attention because it's twice the decision-making. Typically, if you're selling one stock, you're also going to be buying something else. It might be another stock or another asset for your portfolio or perhaps you are moving the money on such as if you're buying a car, a house, kids' college education, or something like that. So, it is complicated.
I'd start with the personal-financial decisions that you might have to make. If you need money from your portfolio, you have some withdrawal that you have to make, money you need to take out in the next couple of years--that money shouldn't be in the stock market in the first place.
If you have, for example, specific debt that's coming due or something like college tuition, scale that money out of the market early. Don't leave yourself vulnerable to having to sell your stocks at very low prices in order to meet that debt obligation at the last minute.
But if the money is staying inside your portfolio, then I tend to think of two kinds of sales. There are defensive sales, and there are offensive sales.
Glaser: What's the difference between those defensive and offensives sales?
Peters: They kind of make sense, I think, in a football-lingo-type of way. Defense is you're literally trying to defend your capital, some money that you got invested in existing stock as well as, in my case, its dividends and the earning power that you have from that from some sudden decline. There's no better way to really have your portfolio go into a ditch than to have a bunch of stocks cut their dividends.
If you see a situation starting to materialize where the dividend is at risk of being cut or eliminated or even you see the dividend growth rate is deteriorating to the point where you can see that maybe in a year or two ahead the dividend stops growing entirely and then starts to decline from there, those are where you have a simpler decision to make. Can I back out of this situation, or is some kind of worst-case scenario already priced in?
Remember you always want to get way out in front of these kind of situations because when everybody realizes the dividend is going to be cut, chances are the stock is already way, way down from where it was. Frontier Communications and Pitney Bowes are a couple of names in the last couple of years that have cut their dividends. They haven't been a surprise, but most of the pain was already in the share price by the time those cuts were announced.
The offensive sales on the other hand are really just trying to move the ball forward, and this is, I think, best accomplished by keeping a set of second stringers around your portfolio at all times. Right now, for example, I own 36 stocks between the Builder and Harvest portfolios in DividendInvestor, but they're pulled out of a universe that maybe 150-200 potential stocks that I could own that meant my basic criteria for yield, narrow and wide economic moats, low and medium fair value uncertainty ratings, and so on.
Obviously, there are some names that I'd be very reluctant to sell, like a General Mills or a Magellan Midstream Partners. These are companies I really would want to hold on to for the very long run. But with my 34th and 35th and 36th best ideas, there's always the chance that there's something in that universe around it that could come in to replace it and do a better job. And I just make those decisions based off of the dividends themselves.
If I can pick up a little more dividend yield for the same underlying rate of earnings and dividend growth, then I'm moving the ball forward. If I can say swap one stock that yields 3% for another stock that yields 3% but the latter has double the potential growth rate, that's moving the ball forward. Even if the yield and growth characteristics look similar, but I think one has better quality, less long-term risk associated with it, that's moving the ball forward. Again casting the question in terms of income and using income to evaluate these trades and the impact they make on my portfolio really helps a lot.
Glaser: If you have this competition between that second stringer that's in your portfolio, how do you manage that versus some of the costs of having higher turnover? How do you know that you're selling too much just to get just an incrementally better portfolio holding?
Peters: Well, you need a pretty good-sized gap. I'm not going to swap stock that yields 3% for one that yields 3.1% unless I'm picking up some pretty significant other advantages, such as a much stronger balance sheet, a much more recession-resistant stream of cash flows, a much better long-term growth rate.
You want to have a spread open up. And you have to remember, too, that if you own a name for many, many years--you maybe have a big capital gain that you might have to pay taxes on and you're familiar with the story, you understand what the management is trying to accomplish, you've read lots of press releases and annual reports, and you're familiar with [the company]--that's an advantage, too. You buy something new that you don't know as well; you might not see the signs of trouble developing perhaps as easily as something that you're familiar with.
There's some tension there. You don't need to optimize your portfolio every moment of every day, and you've got to let the dividends do the work. But sometimes there are times to make those changes, and so I typically look for the advantages to be meaningful, to acquaint myself, to do as good a job as I can getting to know the new stock as well as the old one, and only if there is a big enough gap there to really make it worthwhile, [I determine whether I should] go ahead and pull the trigger.
For us that type of approach has shaken out to about a 17% turnover rate since inception. That's an average holding period of about six years. That seems about right. I think, it's actually going to go up to a longer holding period and lower turnover rate even in the future. We have so many good companies in our portfolios now that I don't ever see the need to sell. But when those sales become necessary, then you want to be able to act on it.
Just recently, Sysco, the food distributor, I decided to sell after having held that stock for almost eight years. The dividend-growth rate had dropped significantly and hadn't made much for capital gains. I still think that company has a shot at better success, but I'm not really seeing that materializing in the next couple of years.
So, I made the jump to Unilever, and I picked up more yield. I picked up a lot more dividend growth, especially in the short term, and I'm getting a business with a lot of global reach that Sysco does not have. So much of Unilever is in emerging markets that have those better long-term growth characteristics.
That was an example of a trade where I really was able to give myself an advantage on multiple fronts. I look for that before I want to make a trade. I never make a trade just for the sake of activity.
Glaser: Josh, thanks for your thoughts today.
Peters: Thank you, too, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.
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