In this article, I will discuss the 7 most common indications to sell a dividend stock. Although you should essentially be "married" to most of your dividend-paying companies, there may be circumstances in which it makes more financial sense to sell your dividend stock positions instead.
The goal of dividend growth investors is to stick with stocks that have consistent dividend payouts, with great dividend growth and dividend yield. Following this strategy, you can take advantage of the double compound effect, where both dividend growth and stock price appreciation play a role in the returns you earn.
Therefore, if anything is threatening this system, you should seriously consider selling the culprit stock.
Below are seven major indications to sell a dividend stock, with several examples to aid your learning. The more (negative) indications a dividend-paying company has, the more I recommend selling the company.
Indication #1: Lack of Dividend Increases
If a year or two has gone by and there has been no dividend increase, assuming no significant market recession, this is typically a huge sign that you should sell your dividend-paying stock!
As dividend investors, we want dividend yield and dividend growth to increase. If it’s not increasing, investors cannot take full advantage of the compounding effect. Therefore, if after a year or two there are no more dividend increases, sell the stock, regardless of any other indications.
A lack of dividend increases is typically due to a company who is struggling to manage its cash, often because of high and unmanageable amounts of debt. This could eventually lead to a complete dividend cut or suspension.
One way to analyze dividend growth is through the free version of Seeking Alpha, a great resource for dividend investors. Simply search for a company in their search box, click on the dividends tab, and select "Dividend Growth" or "Dividend History." From there you can view the dividend growth rates, how often dividends are paid, the dividend amounts, and how much in specific the dividend grows each year.
Johnson & Johnson Example
Johnson & Johnson (JNJ) is a mega blue-chip company that operates in the consumer, pharmaceutical, and medical devices industry.
Their growth rate can be seen below:
For JNJ, the dividend they payout grows at a steady and constant rate, at about 6% annually, and has been growing for 57 years, both of which are ideal for dividend growth investors.
Similarly, you can look at the "Dividend History" tab to see when exactly JNJ pays out dividends, how much this is, and to see JNJ's dividend history for every year:
Clearly, JNJ consistently grows its dividend and pays out dividends on a quarterly basis.
As mentioned before, JNJ has a long history (57 years) of growing its dividends consistently. Even in recessions, such as the 2008-2009 subprime mortgage crises, JNJ continued to payout and grow its dividend. Clearly, this is one sign of a company with strong management and cash flow.
Abercrombie & Fitch Co. Example
Abercrombie & Fitch Co. (ANF) generates revenue through selling apparel, personal care, and accessories to the general public.
Their dividend history can be seen below:
Clearly, ANF is a company you'd want to stay away from if you were investing in it for dividends. Although ANF is consistent with its dividends, and has been paying since 2004, the last time it has grown its dividend was in early 2013!
Therefore, if you were invested in this retail company for dividends, it would likely be a good choice to sell your stake in this company immediately.
Indication #2: Dividend Cut
If a dividend-paying company ever cuts or suspends its dividend, you obviously want to sell your shares immediately. If there’s no dividends, there’s no dividend compounding. If there’s no dividend compounding, the whole system gets ruined and the dividend growth investment strategy falls flat!
Therefore, if a company’s dividends get cut, sell your investment immediately, regardless of why they’ve been cut (in almost all cases). If a dividend-paying company cuts its dividends once, they will likely do it again, which we of course don’t want.
Dividend cuts are also often a strong sign of a company with little to no cash, which could mean poor management, unmanageable amounts of debt, bankruptcy, or a failing business model.
These cuts are also more common during recessions where many companies are generating less in revenue, so we should look for companies that sustain or even grow their dividend during these times.
Below is the dividend history for Citigroup (C), a diversified financial services company:
From early 2009 to 2015, Citigroup suspended its dividend (or had it at $0.01 per share quarterly). In this case, the dividend suspension was largely due to the 2008-2009 subprime mortgage crisis and recession.
So, if you had stake in Citigroup for its substantial dividend pre-2008, with all things considered at the time, it would be obvious to sell this stock after it had been cut.
Indication #3: Drastic Dividend Payout Ratio Changes
If the dividend payout ratio increases or decreases ~10% or more in a short-period of time, you may want to consider selling your dividend-paying stock.
A sudden increase in the payout ratio does not mean that you will be getting more dividends, which some may assume. What it really means is that a company may not be generating enough profit and is fooling shareholders by making it seem like you’re getting more in dividends. On the other hand, companies may also drastically reduce their dividend payout ratio, which leads to a lower future dividend payment. This is typically done to preserve cash, reinvest in the company, or buyback company stock.
Understandably, this is something we do not want, as companies with a lower dividend payout ratio are not paying enough to dividend investors for holding their stock. Furthermore, these companies are likely not the most financially sound either. If you experience this with one of your dividend-paying stocks, you should find out the reason for the increase or decrease in the payout ratio. If you cannot find a good explanation and/or if you feel your dividend is threatened by other metrics as well, I would sell the dividend-paying stock.
The dividend payout ratio can be calculated (in two ways) using the formula below:
Dividend payout ratio = Dividends paid (or dividends per share) / Net income (or earnings per share)
You can analyze this dividend payout ratio on Seeking Alpha as well, through the "Dividend Safety" tab.
Western Digital Corporation Example
Western Digital Corporation (WDC) is known for its hard disk drives (HDDs) and solid state drives (SSDs) for computing devices.
WDC has less than 10 years of paying out dividends, which already makes it a riskier dividend investment. Nonetheless, let us look at their dividend payout ratio history:
Clearly, there are significant jumps here in the dividend payout ratio. Furthermore, the dividend payout ratio is far above the ideal ~50% ratio we should be looking for.
Looking at WDC's dividend history, among other measures, it's evident that this company will likely struggle to continue to sustain its dividend. More research may be needed, but in general, if you had purchased WDC shares for its dividend, selling this stock and allocating the cash to a better dividend-paying company would be wise.
Indication #4: Credit Rating Downgrades
When companies are evaluated and graded based on their financial standings, this refers to credit ratings. Rating agencies are the organizations that are tasked to evaluate companies and give them a grade based on their financial standings. This grade helps investors determine whether to invest in a specific company or not.
The most popular rating agencies are Standard & Poor’s, Moody’s, Fitch, and Morningstar (DBRS). You can use the credit agency table on this website for guidance.
In specific, this grade helps investors determine how risky an investment is, with higher-rated companies being rated as less likely to crash or lose substantial stock value. Rating agencies evaluate these companies based on letter grades, from triple-A to D-letter grades. A low rating does not necessarily mean that it's extremely risky. It more so suggests that you should completely avoid investing in the company. It also does not mean high risk, high reward.
Therefore, a credit rating shows how good a company's financial standing is and its ability to pay off debt that has accumulated over the years. It also predicts the potential of a stock's price to increase over the following years.
Companies that experience a downgrade to their credit rating are at risk of higher borrowing costs when they issue new debt. Ultimately, this can lead to companies suspending their dividend to preserve cash flow and to prevent further credit rating downgrades. So, whenever a dividend-paying company you've invested in has its credit rating downgraded by a rating agency, you should investigate this downgrade and consider selling the stock.
Exxon Mobil Corporation Example
Exxon Mobil Corporation (XOM) is a multinational oil and gas dividend-paying energy company.
Moody's recently downgraded XOM's credit rating on April 2nd, 2020 to an Aa1 rating, which is still a high grade rating:
Although this Aa1 rating is still very high, I would look into XON's financial statements or just read Moody's "Rating Action" document type for the downgrade date under the "Research" tab.
Afterwards, you can use this information to help you make a decision on whether to continue holding/purchasing the stock for its dividends. Note that you must sign up for Moody's (for free) to view this information and to search for other credit ratings.
Indication #5: Elimination of Stock Buybacks
Companies that have higher cash reserves tend to buyback a lot of their company’s shares (with cash) and accumulate it for themselves. Through buying back company shares, fewer shares are available for purchase to the public.
This is especially prevalent in lower interest rate environments where more stock buybacks are issued by companies, as they can do so by issuing cheap corporate debt.
This becomes a supply-and-demand situation, where a shortage in supply leads to an increase in demand. If there are fewer stocks for a particular company in the stock market available for purchase, this may lead to an increase in demand. Ultimately, the remaining shares for this company would then become more valuable.
The problem here is when dividend-paying companies suspend their stock buyback programs. When this happens, companies typically do not have enough cash or too much debt to support the stock buyback program. Naturally, if a company cannot support its stock buyback program with its cash, a dividend cut or reduction would likely follow afterwards.
How to Keep Track of Stock Buybacks
In general, it's difficult to keep track of specific stock buybacks as they are unknown to the general public until they're realized. However, companies may sometimes announce stock buyback's to their shareholders. In addition, you can look at a company's quarterly financial statements to see whether the number of outstanding shares has shrunk.
Indication #6: Falling Stock Price and Higher Dividend Yield
As you may know, a good starting yield of around 3% or higher is ideal for dividend growth investing. However, a starting yield above 7%, in most cases, may be indicative of an attractively priced dividend that is not sustainable in the long-term. This is what is known as a "yield trap."
It's important to remember that increases in a dividend-paying company's share price will reduce the dividend yield ratio. On the other hand, decreases to a dividend-paying company's share price would lead to a higher dividend yield.
Below is the dividend yield formula, which may help you make sense of this concept:
Dividend yield = Annual dividend per share / Stock price
Often times, when a company's share price continues to decrease and it wants to continue paying dividends (as its yield is now attractive), it will begin cutting company costs, allocating important cash within the company to fund dividend payments, or even take on more debt and sell shares to raise cash for dividends.
Eventually, companies that do this will be overwhelmed by debt and poor cash management, which will force them to cut their dividend. To avoid this situation, keep track of your dividend company's share price, which direction it's generally moving, and how much the dividend yield has changed since your initial investment.
Obviously, falling stock prices is not good news, but dividend investors often ignore short-term price movements because of the long-term nature of dividends and compounding. So, if you notice that one of your dividend-paying companies is performing poorly on the stock market and has a higher dividend yield, attempt to find the underlying reason behind this poor performance.
Indication #7: Drastic Stock Price Increases
The final major sign that you should consider, that many dividend investors overlook, is a dramatic increase in the company's stock price. I’m not referring to small stock price changes or stock price changes that follow the market, as these are completely normal.
What I’m referring to are sudden stock price increases, such as 10% or more within a two-three day period. In these cases, I would typically sell a portion of the stocks I own with this company. Not all, just a portion, like around 15%.
When there’s a dramatic increase in a stock's price, it’s often followed by a dramatic decrease. So, to take advantage of this spike, sell about 15% of your stocks at the high price (based off what you know), and when it starts to level out around what it was prior, you want to buy back into the stock.
Don't try to time the stock and keep your emotions in check! Even if the stock price continues to ride this high level for a long-period of time, you really have nothing to lose, as you gained capital from selling a portion of your stocks and likely have unrealized gains in your portfolio. You can also choose to reinvest these gains back into other dividend-paying stocks that are valued at good prices.
The longer you have a portfolio of dividend-paying stocks, the more often this will occur. So, it's best to keep a tab on all of your stock price fluctuations. Even the most "stable" and "safe" dividend-paying stocks will fluctuate at some point, so do not ignore these stocks!
Coca-Cola Company Example
Take the Coca-Cola Company (KO) for example, a multinational beverage company that has a long history of paying out dividends:
As you can see, there are many peaks and dips that occur within KO's history over a few days time (like every other stock). Long-term dividend investors could use this to their advantage by selling a small portion of their returns and reinvesting it back into the stock at a later date. These investors could also reinvest the returns into more attractively-priced dividend-paying stocks.
This is a strategy that many dividend investors overlook, as they do not want to harm their long-term dividend cash flows. This is why we only sell a small portion of our shares, and do so only when the growth is above ~10%, to ensure the returns outweigh the potential losses in dividends.
Dividend Coverage Ratio
The dividend coverage ratio determines the number of times a company can pay dividends to its shareholders. This ratio is useful in determining whether a company is able to sustain and grow its current level of dividend payments:
Dividend coverage = Earnings per share (EPS) / Annual dividend per share
As a general rule, after solving for the dividend coverage ratio, use the below measures to determine whether or not your dividend is considered safe:
- < 1: The company is paying more in dividends than they are earning. This is not sustainable at all and very risky.
- 1: The company is paying 100% of its earnings in dividends. Every dollar coming in is going back out to shareholders. Again, this is not a safe dividend whatsoever.
- 1 – 1.5: This measure should also be classified as unsafe, and there will likely be a dividend cut in the near future.
- 1.5 – 2: Likely a safe dividend, as it indicates a healthy amount of earnings and dividends. A high score like this tells investors that the company is paying enough to its shareholders but also allocating the rest back into the company to remain competitive.
- > 2: A very safe and healthy ratio. Any ratio above 2 is ideal for dividend investors.
McDonald's Corporation Example
McDonald's Corporation (MCD) is a multinational American fast food company that pays dividends. We will use this company's financials to calculate its dividend coverage ratio, as shown below:
MCD's dividend coverage (2019) = $7.88 / $5.00 --> 1.576
Therefore, based on the dividend coverage ratio of 1.576 alone, MCD's dividend can be considered as safe. More research should be done of course, but this is fairly accurate given MCD's business model and 44 years of dividend growth.
The Bottom Line
Although there may appear to be many indications to sell a dividend stock, it really all boils down to whether the company is managing itself and using its cash effectively. If you've invested in the right dividend-paying companies at the right price, then a majority of these indicators you will likely never have to worry about.
More often than not, large blue-chip dividend-paying companies with strong management have manageable amounts of debt, and use cash in an effective manner. These companies are also so dominant and diversified that they still have enough room to grow and continue paying out dividends. However, with smaller-cap dividend-paying companies, or those in more risk-prone industries, you may need to fully utilize this list and the dividend coverage ratio to your advantage.