For nearly a year now we’ve probed dividend stocks from every angle on this site. The investment advice world is filled with tips on buying dividend stocks. There’s rarely any advice about selling. No one ever mentions when to sell dividend stocks.
Admittedly, we’re just as guilty as everyone else for ignoring this crucial topic. Most of our articles are either about gauging dividend paying companies, valuing stocks, finding income-worthy investments, or buying stocks for the long term.
While a good rule of thumb is to hold dividend stocks forever, that doesn’t mean you must never sell once you’ve bought it. Things change as time goes on, and every few months or so I advise you to look back at your dividend portfolio and question why you hold what you do. Take a closer look at every stock and try to ask yourself if it’s a good time to sell.
So, I’m going to take this opportunity to clearly outline when to sell dividend stocks.
The Art of Selling Stocks
Business and markets are unpredictable. 99% of the time doing nothing is your best option. The remaining 1% of the time you will either buy new stocks or sell the ones you own. If you’ve followed this blog closely for the past year, you already know we’re value-contrarian investors. In other words, we advise you to buy stocks that are selling for less than they’re worth. You calculate the intrinsic value of the stock and then attempt to buy it for a deep discount (or margin of safety).
Selling a dividend stock needs a similar strategy to maximize value. There are three scenarios where you should consider selling the stock:
Let’s kick things off with the most depressing scenario – a change in fundamentals. If you bought a stock based on its forecast for a bright future and stable cash flows, you might want to let it go if it doesn’t live up to expectations. A sudden dip in profits, a change in the industry, a sexy new competitor with a better product, or a sharp decline in the country’s economy should change your valuation of the stock.
The best example is probably Blockbuster. For decades, Blockbuster was synonymous with home movies. The company hit its peak in 2004, when it had 60,000 employees and 9,000 stores spread across the country. The company earned more than $6 billion a year in revenue and paid out a handsome dividend yield of nearly 1%. That dividend yield wasn’t impressive at the time, but the company’s lack of profitability led to a decline in the stock price over the next five years. However, the old retail model for home video and DVD rentals was no match for the juggernaut Netflix would eventually become. Netflix eradicated Blockbuster’s model and by 2010 the company filed for bankruptcy. Blockbuster essentially went from peak to bust in six short years.
So, a sudden change in economics or a wild new competitor is the kind of stuff income-oriented investors need to keep an eye out for. Dividend paying companies can seem deceptively attractive if you are not paying attention to their business model or technological trends that affect them.
Sell a dividend stock when the fundamentals change.
Now let’s talk about more favorable scenarios. Investment is not just about risk and reward. There’s also an opportunity cost with every investment. Every time you buy a stock, you essentially say ‘no’ to a million others. There’s no doubt you will miss out on opportunities, so you need to balance the opportunity cost with the cost of investment.
In other words, a good time to sell would be when you have better use for the money. If you hold a stock that is trading at a 10% discount to intrinsic value, it would make sense if you sold and bought a stock trading at an estimated 40% discount to intrinsic value. A chance at better returns is a good reason to reorganize the dividend portfolio.
Perhaps the best reason to sell is overvaluation. There’s simply no better feeling than selling a stock for far more than it is worth and capturing the profits you have made after months or years of patience.
In my opinion, you need a margin for selling too. If the margin of safety is between 15% or more, you should expect to sell once the market value of a stock reaches 15% or more of the intrinsic value.
Of course, figuring out what price to sell and how long to wait is up to you. Exercise judgement and wait for the perfect opportunity to maximize the price you get for your holdings.
As a long-term, income seeking investor, not acting on sudden moves in the market is often your best option. Consider buying more stock if you believe the market is being overly pessimistic and the stock price trades below your estimate of fair value. However, consider selling your stake or trimming it when the stock is overvalued, the fundamentals change, or you find a better opportunity.