Deciding Whether I Should Sell Stocks in my Dividend Investment Portfolio

I have been investing in dividend paying stocks for a few years now, and I am at a cross roads.  I have some pretty good capital gains (percentage wise, not whole dollar amounts) that I am not exactly sure what to do with.  My gut is fighting with my head and I am not sure who to side with.   I think a bit of history regarding my past 3 years with dividend paying stocks might be helpful.

Looking back through my archives I created my perpetual income machine in February of 2010.  That portfolio was held at sharebuilder so I was able to buy fractional shares of multiple companies for a very low price.  Essentially I was buying very small pieces of companies since I was able to buy into 6 to 12 companies for the same $12/month.  So that is what I continued to do (providing 10 or so updates) until my employer told me I had to switch brokers.  I decided to move the account over to Fidelity and retitled the account, Dividend Investment Portfolio (July 2011).  The main difference was that I had to focus on one purchase per month since I no longer had a batch price per trade.  I also started to include income ETFs since they were free to trade on Fidelity.  Eventually, I learned about the other dividend lists that exist besides the dividend aristocrat list and I started using the dividend champion list (October 2011).  From that October 2011 post, the only thing that has changed that I dropped those ETFs and just kept going strong on the account. My main concern was pumping up the cash reserves so I was investing $500 or so a month into the account, but recently that has changed.

Side Note: It is amazing how much my life has changed since I started that account.  Thinking back to February 2010 feels like a different life.  The Wife and I had already suffered one miscarriage (second miscarriage as you might remember was just a few months ago) and we were in the middle of trying for our boy that wasn’t born until December 2010.  Amazing.  In some of those old posts I even discuss saving cash for an eventual move.   Little did I know that it was nearly 24 months after I made mention of it in that first perpetual income machine post.  But, I digress.

I am Not Sure Whether to Capture Some Gains on my Dividend Account

Through a combination of hard work and pure dumb luck this account is up and some of those gains are too large in terms of percentages to ignore (unless I actively choose to do so) – you may have to click the picture to zoom in.

Dividend 1

Dividend 2

I will admit that some of these feelings I think are based on the fact that the market keeps hitting new highs.  If there is a correction these are all pretty big names they are going to get hammered in the fall out regardless of whether they deserve it or not.

My Options Regarding Huge Gains in My Portfolio Focused on Dividends

I came up with 4 options:

  1. Leave the account and ignore the market noise – This account is not for 31 or even 35 year old Evan, but more like 40+ Evan so who cares if there is a hiccup.  The obvious counterargument is that if I can capture some of the gain and use it elsewhere I am setting myself up for even bigger gains when compared to the broad market.
  2. Sell the crazy high ones and start over – Some of those gains are closing in on 30 and 40% even when compared to the broad market these are wins.  Sell the entire lot.  Obvious problems with this option is that I am ignoring why I created the account.  Not much discipline there, plus I am starting my yield on cost all over again.  Probably my least favorite option.
  3. Sell just the gain – Take the gain off the table.  Better than option number 2, but still has the same problems.
  4. Research those that are flying high and only sell if their valuations are all out of whack -  Interesting option.  I would be reverse engineering the reason I bought the stocks.

What Did the Experts Say?

Forget researching the opinion of people who I’ve never met or read I went to two of my favorite dividend gurus, Dividend Growth Investor and Dividend Monk.  These guys are swamped in this world and have had to face it before.  Interestingly, I got two very different answers.

Dividend Growth Investor provided me with 2 links on the subject which he wrote years ago.  Both basically said the same thing – Why would you sell your dividend stocks if nothing has changed about the business?  His feelings are that you are buying for income and every time the stock increases in price all you are doing is ratcheting up your yield on cost.  So, DGI is for Option #1.

During my conversation with Dividend Monk I discovered that this guy is WAY smarter than I when it comes to investing.  Matt, who has a great dividend toolkit and has commented on my portfolio back in 2010, opted for Option #4.   His point was that if they are overvalued they could be overvalued for YEARS and if you can unlock that money and use it for other growth opportunities.  The conversation started to get away from me when he named some ways that I am unfamiliar with in valuing a company.  Researching the acronyms he provided left me confused and reminded me of the “C” I literally begged for in College Calculus.

Considering how much I respect those guys, and I have never been lazy when it comes to the account (just most other things in my life) lets take options 2 and 3 off the table.

Before I make a decision I’d love to hear from others!  

  • Do I ignore the gains and hope that 40 Year Old Evan (who will be better looking I presume) is happy with my decision today OR Do I unlock some of those gains (somehow learning what the F’ DM is talking about) and put it in other dividend growth opportunities?

30 Responses to Deciding Whether I Should Sell Stocks in my Dividend Investment Portfolio

  1. My recommendation is option 1, but put some stop limit orders in on the ones that concern you as overvalued. I put my stop limit at 5% when I start to get that itchy feeling. That provides a good amount of breathing room for the stock to move, but if there is a decided downward trend it will eventually trigger. My hope is always that they don’t trigger, and I continue to reap gains through dividends and stock appreciation. Note most stop limit orders are forced to expire on meaningful stock events. Dividends count as a meaningful event in most cases so you’ll have to redo to the orders post-dividend, but that’s just a quarterly fix.

    • Maybe you can wrap my head around this – but lets say the equity in question drops 5% in price, but that has nothing to do with the metrics of the company but some bad news you don’t really care about…in fact maybe you’d buy on that dip aren’t you being counterproductive? and maybe causing you a big tax bill?

      For example (and I am very obviously cherry picking, just trying to understand the reasoning though) – AFL hits about $53.50 on 2/5/13 and Dividend is paid out on 2/13/13 and drops 7% ish…your stop loss would have been called, right? Automatically?

  2. Thanks for including me in your decision making process. When I reviewed companies like MCD, PG, JNJ in the 1980′s and 1990′s, I noticed that they were very often richly valued. However, the underlying businesses generated high growth in earnings and dividends, which pushed the shares higher. As a result, someone who managed to simply buy some shares at a reasonable price, could have simply stayed put and enjoyed a rising stream of dividends and increase in stock prices. My underlying idea is that if nothing has changed, then why bother selling? Because if you sell, you would have to find another company to reinvest your money into. With markets at all-time highs, it is getting tougher to find good replacements.

    Now I did sell companies like ED in 2012, because the expected EPS and DPS growth was very low. The past growth had been low as well, but my entry price was low as well. Now ED was overvalued, relative to other companies like OKS for example. I also sell after a dividend cut, but of course what you do is up to you.

    My question to you is, why did you purchase each of these stocks in the first place?

    • How the hell did anyone review companies in the 80s and even the 90s? It takes me an hour or more to do my screens and I have the help of morningstar.com!

      I guess my problem is where do you come up with – “expected EPS and DPS growth was very low.” Maybe you are and Matt aren’t that different?

      I agree with dropping dividend cuts.

      I started the account for a future income stream, BUT can I build that income stream faster by allocating gains to something that might grow faster then using those gains elsewhere…I didn’t create the post for academic purposes really trying to figure out what to do. Plus it would just be terrible to watch all those gains go down the tube lol.

    • I essentially agree with DGI’s answer above. I don’t think our fundamental opinions on this are extremely different.

      In his comment, he sold ED because EPS/DPS growth was low and it was considerably overvalued compared to other options.

      I’m willing to sell an investment if it’s overvalued, which fundamentally means that the sum of dividend yield and EPS/DPS growth is no longer attractive. Selling means taxes, fees, time, etc, so there has to be a significant gain to be made by selling to make it worthwhile rather than little portfolio tweaks here and there. So in practice, I follow a path of very low portfolio turnover.

      • Do you consider the percentages above worth going in on? or does it come down to a whole number for you.

        P.S. Thank you for the emails.

  3. This is something I’m needing to do with my portfolio as well. I have a few very small positions that have seen some great appreciation and the decision needs to be made. Hold, sell some, or sell all. There’s 2 positions that I’m leaning strongly towards closing the position and since their small selling just the gain doesn’t make sense because the commission will eat too much of the profit. I don’t think either one is at an extreme overvaluation level but they aren’t contributing as much to the dividend income and the market just seems toppy.

    There’s nothing wrong with taking a profit and sitting on cash for better opportunities. It’s more a matter of whether you think those opportunities will come relatively soon 1-3 months to not shoot yourself with the loss opportunity from being out of the market.

    • I like that final point. Evan, do you really want to be sitting on cash when you could still be getting the dividend. Again, a stop-limit order would work in this situation to protect your downside while still allowing you participate in the upside and dividend.

      • @Slug and @JC,

        I would reinvest the proceeds very quickly (using the screen I set up every couple months). I wouldn’t just let it sit there missing out on the dividend payment. Completely agree with both of you.

  4. I have slowly started building a dividend portfolio. ETFs and stocks like INTC, JNJ, EPD, MO etc. I am not going to sell them in near future.

    I need to check out your past posts, about what you do with your accumulated dividends, do you re invest in same stock or buy another one? I am with Merill Lynch, they don’t offer auto reinvestment option.

    • I reinvest dividends only b/c with Fidelity they are free. Since the account is not that big in size, my total dividends for the year would be around what I would buy one equity lot with (i.e. $500 to $1000) seems silly to worry about it right now.

      As the account grows and the dividends become more substantial I will turn off the reinvestment option.

      Notwithstanding, Why are you with ML? Don’t they charge an arm and a leg per trade?

  5. I’d combine #4 with part of #3. If valuations seem to be out of whack, I take my original investment out and leave the gain… i.e. play with the house’s money.

    As you said before “I can tell when a stock is undervalued (or at least I think I can)…” That’s where I’d put the money that I pulled out from selling the overvalued positions.

    The result is that you have a trail of stock behind you as you move to new positions. These bread crumb stocks are all profit, so if one pulls an Enron it’s not like you can say, “Easy come, easy go.”

    I’ve been using this, but I’m not doing it with the context of growing dividends, just overall asset value.

    • I like that idea…seems to flow with DGI and DM also. Not sure I can do it just yet though. I didn’t share the information, but the whole dollar amounts on some of those gains would make it cost prohibitive. For example, VFC while showing an 80% gain, that is only a couple hundred bucks since I bought it in the days of sharebuilder and didn’t buy all that much (fractional shares). So to take what I put in off the table may be impossible since I can’t sell fractionally (not to mention fees and what am I going to do with two hundred dollars).

      I do like the idea of removing my capital to go elsewhere, but still leaves me with the questions of what about my stream of income.

      Sorry for the wishy washy response, just thinking aloud here

  6. I also agree with DGI. As a dividend investor. Personally I am more concerned with what I can get in dividends per month to add to my pension that I will eventually receive. I don’t really care if a stock fluctuates up or down 10+/- % as long as in the long term the company does have slow steady growth and overall stability. I’ll continue buying shares until I get the target monthly income I’m looking for.

    • So do you have as many holdings as I have? Or do you really focus on buying a ton of one particular stock? What do you mean by target monthly income?

      • I keep it simple. I have a mix of stocks and when I don’t feel that I can find a stock on my own in a certain sector (ie : health care) I’m comfortable owning, I buy a dividend producing ETF to cover it.

        No matter how much I fall in love with a stock I won’t keep more than 3 to 5% of my holdings in any one stock. (To limit my loss in a total meltdown). ETF’s of course you can hold more.

        To explain my monthly “Target”…
        I have been able to contribute the required amount to receive the maximum monthly pension benefit. I also know roughly what I spend a month for me to be happy. (I don’t want to live in a trailer and cook a stew to last me all week and be proud of that? That is definitely not for me). I’m more of a “sit in the hot tub with a flat screen with a game on (outside) clipped on the wall of my house in the winter kind of guy”. But by no means is that all I do, just an example of me spoiling myself and wanting to have the opportunity to continue to do so later in life. Hey… at least I admit it.

        I’m still pretty far away from retirement age. At the moment my monthly distributions throw off an avg. of $550.00 per month. I reinvest most of it. Plus I can easily put 30% of what I make each year into investing additionally. It’s fun to watch when you get your statements and it’s just a little bit more every month. That amount is not a lot yet, but one day I hope it to be 3 or 4 times that per month. So that is my target. Looking back at the meltdown I try to hold stocks that continued paying distributions even during that crisis.

        Since I have no debt and the house is paid I feel I can achieve that eventually and be “comfortable” Not rich, just the right amount for me….

  7. Well, I’m an oddball out on this. I have a tendency to not DRIP (reinvest dividends).
    I’m admittedly a novice when it comes to dividend investing, however when I purchase a stock, I repeatedly setup buy/sell orders for the ranges that I believe it will trade in between, making sure not only to get the dividend (or grow to the same level prior to hitting the ex-dividend date), and also the transaction fee. So I’ve been trying to increase portfolio while locking in the gains.

    However when I have picked the shares up at a low enough level, I have found myself getting a tendency to hold. By that I mean that the stock will likely not hit the lower level for 6-12 months.

    Strangely enough, I just kind of “eyeball” the lower and upper levels. I’ve been quite lucky for the past 28 months since the CAGR has been 27.5%+, although the real growth rate was 88% in that period of time, counting paying the transaction fees.
    Granted that window has been pretty nice in the market in general throughout that window, but I have more than completely recovered the 75% losses that I incurred because I was buying and holding only (even when the market kept sinking). I won’t repeat that again.

    • At what scale are you doing this? I only ask because if it is anything under $5k or 10K wouldn’t you get killed in transaction costs?

      I am actually not a fan of the auto reinvest but I do it because at my broker it is free. So since the income isn’t huge (YET lol) it is easier just to collect the few bucks.

  8. Very interesting discussion and a problem that any of us that have held stocks for any length of time will face. Helps to put small increases in perspective when you consider that investors who had invested in mcdonalds 10 years ago would have 8x their investment, while those in Coca Cola in 1970 would today have almost 176x their investment. Before making your decision to sell, i would make sure that your place to park your cash is better than where it currently is before you look for any gain. In the long term though, you may be better advised to keep with what you have if the business is a solid one with sustainable competitive advantages. These businesses are hard to come by, and even harder to replace.

    • I would probably just take some off the table and reinvest it in a different dividend champion that I find is undervalued. I wouldn’t just leave it in cash.

      “that investors who had invested in mcdonalds 10 years ago would have 8x their investment, while those in Coca Cola in 1970 would today have almost 176x their investment.”
      - The question is whether I can sell some McDonalds to buy some Cokes!

  9. ya gotta read Chuck Carnevale on SA. He just posted on this issue.
    If you have the right view you can rotate out of the over-valued into similar equities with more appropriate valuation, keep your strategy intact and harvest the disequilibrium of the market. I understand the “re-setting”of the yield on cost, but remember, each time you reinvest dividends, a little piece of your holdings has the new baseline yield. It’s just diluted into the larger chunk of your earlier purchases. You can’t let that little issue constrain you from doing the right thing. Whether you call it rebalancing, selective dividend re-investment or selling over-valued companies, if you attach a sentimental value to a company, or a number like yield-on-cost, you may be passing up an opportunity to improve your total return while also boosting the real-dollar dividend yield on your current portfolio. Yield on cost is a back-wards look at the value of your prior decisions. It isn’t informing you of what is the best risk-adjusted investment looking forward.
    Whatever you do, whether it is selling gains, rebalancing to a specific proportion of your portfolio, etc., it only makes sense if you have a better target than the one you’re in, unless you intend to go to cash.
    Even cash is helpful if you like cash-covered puts, but cash for cash’s sake is currently trash, except for the doom’s-day prophet.

    • Nathan,

      Is this the article? http://seekingalpha.com/article/1374951-many-of-my-dividend-growth-stocks-have-become-overvalued-what-do-i-do-now

      This account never has any real cash in it that doesn’t make sense. I do have a pretty good emergency fund right now, so that’s where my cash sits. I would sell and reinvest almost the same day.

      You make some great points as the does the article you mention (as does the other great commenters above). My next step is trying to figure out what is “overvalued” to me. The author you mentioned talks about multiple metrics (some of which I had never heard of).

      I think the first step is to see what is GROSSLY overvalued (if anything) – maybe by checking historical PE on each of the stocks? And go from there.

      Thoughts?

      • That’s the one…I’ve been searching for metrics that mean something to me for some years now. I’ve come to the following conclusions;

        Start with earnings and earnings growth rates, then look at dividends and dividend growth rates. compare them; the proportion of earnings attributed dividends shouldn’t be too high or two low, but they vary from industry to industry. Rising dividends in the face of declining earnings is a red-flag for a company about to take a dive.

        for purchase points, P/E is a fine metric, as long as it is taken into the context of historic P/E for the stock and it’s sector. It’s always great to purchase at fair value or under. Depending on the growth rate, most folks believe that a P/E of 15 represents fair value for most companies, although those that are growing rapidly may have higher P/E all the time. Other blue chips constantly trade at premium to “fair value”, and there are some that never trade at a P/E of 15. The real key is where the P/E lies with respect to historic values and whether there is a fundamental reason for it having changed. You can rely on earnings and earnings growth rates to keep you out of trouble, as long as you don’t buy those earnings at too high a price.

        There are plenty of other metrics, but I’ve been doing just fine with the simple ones. With MLPs, BDC’s and REITs, one substitutes cash flow for earnings, but that’s about the only modification required

        Chuck Carnevale has a great tool called FastGraphs that puts all this into graphic form. it’s well worth the price. I started with the cheap version and used it for a while during the time I learned how to interpret the data, but quickly realized that the higher price version is well worth the 40/month, both to guide purchases as well as track my portfolio and model portfolios.

        I read the dividends and income section on Seeking Alpha regularly. I have developed a robust list of favorite authors who help me understand how to interpret the space. If you haven’t looked it over, be sure to spend some time there. If you’re interested I can give you my list of favorite authors who make the most sense out of dividend growth investing.

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