3 Reasons to Sell a Dividend Stock

Good times, Bad times

This site provides quite a bit of information on what to look for when buying a dividend stock, so this will be an article on reasons to sell a dividend stock. Knowing when to sell a stock can be hard, especially for an investor that wishes to ideally hold onto his or her stocks for a very long time. Yet, there are certain times when selling an investment is the right thing to do.

Reason 1: Dividend Cut

If an investor invests in a company seeking long-term growing passive income streams in the form of dividends, but the company they invested in one day reduces or eliminates its dividend, then it is often an appropriate time to sell. Firstly, you’ll have lost some passive income, and secondly, other income investors are likely to reduce their holdings for the same reason. Under some circumstances it may be a reasonable decision to continue holding onto the stock, but in many instances this is one of the most clear-cut red flags that it is time to move on.

Reason 2: Major Change

If a company changes dramatically, its usefulness as an investment to you might change considerably. For context, consider reading my previous article about writing an investing thesis. In that article, I discussed the merits of writing down and saving your investing thesis, which is your summary of qualitative and quantitative reasons for purchasing the stock of that company. It’s good practice to periodically review your investments and ensure that you still own them for logical reasons. If the company has changed significantly from the way it was when you purchased it as an investment, your reasons for purchasing stock in that company may no longer exist in that company. Examples of major changes that may affect your interest in holding the stock are massive acquisitions and mergers, or a re-focusing of the business, or a huge macro-economic shift, or that the company is increasing their debt beyond the point that you are comfortable with.

Reason 3: Overpriced

“Buy low and sell high” is the mantra of a lot of investors, but is not so often spoken by dividend investors. People wise enough to avoid trying to time the market look at this phrase with a bit of skepticism, and for good reason. Many dividend investors are comfortable holding onto their investments even as they soar in value far above what they are realistically worth because they are mostly focused on the dividend income rather than the stock price.

Take a look at Coca Cola. In the late 1990s, Coca Cola’s stock price soared to incredible highs before crashing back down to reality. During the high, Coke had an astoundingly high P/E, and a dividend yield of under 1% despite paying out a considerable percentage of their profits as dividends.

What I’m not suggesting is that you try to time the market. That’s usually a fool’s errand. What I’m suggesting is that you keep tabs on the fundamental value of your stocks, and if they have grown in price to a level far beyond what you would be willing to pay today, then it may be wise to sell if you can find a better deal to put your money into. Taxes should be taken into account for the decision.

If, for example, you purchase a stock for $30 that pays $1 in dividends this year, then the calculated dividend yield of this investment is 3.33%. If, in 10 years, the profits and dividend have only increased by an average of 10% annually, but the stock price has increased by an average of 20% annually, then the stock value will be worth over $185 and it will be paying out about $2.60 in dividends that year. This is calculated to be a dividend yield of only about 1.40%. If the investor concludes that his purchase is now over-valued, he or she can sell this company and purchase perhaps a different investment that currently yields 3.33% along with considerable growth opportunities like his original investment once did. If he does this, his $185 (taxed down to perhaps $140) with a 3.33% dividend yield will give him $4.66 in dividends per year instead of $2.60. This makes a huge difference if you have a large number of shares.

I wouldn’t recommend selling due to overpricing, however, unless the stock price is far out of proportion with what you consider its value to be. I personally continue to own dividend stocks that I think are overvalued as long as it’s not beyond a certain reasonable point.

Parting is such sweet sorrow…

As long-term investors, and not short-term traders or speculators, many of us really do look at our portfolio as a list of companies we own. That is, of course, what a share is- a share of ownership in a company. While selling stock might be easy for someone who doesn’t look at it this way (and indeed, many people simply look at stocks as simply pieces of paper that fluctuate in value), it can be difficult for someone who has a more fundamental view of investing and holding. While we’d like all of our investment choices to be perfect ones, where our holding period is “forever” as one famous investor would say, some of them will inevitably not be.

All in all, I do think it’s better to be someone who has a tendency to continue to hold stocks when it is no longer appropriate to do so, than to be someone who doesn’t hold onto their stocks for as long as they should and is far too quick to sell under a variety of scenarios. Nonetheless, it makes sense to periodically review your investments to ensure that they still make sense.