It could be a company that cuts its dividend or in some cases freezes its dividend (fails to raise its dividend at the appointed time). Let's take a look at a two-step process designed to help us determine if we should sell a stock after a dividend freeze.
I. Does The Stock Still Meet Our Investment Criteria?Investing in dividend growth stocks is about building a reliable income stream that increases each year. When an investment stops raising its dividend, it is no longer providing the future income growth required by my dividend growth portfolio. The stock may still be a good value, but my dividend portfolio’s primary objective is an ever-increasing dividend income, not capital gains.
Obviously, the company's future prospects would play into a decision to keep or sell. Can the company raise its dividend, albeit late, and still preserve a year-over-year increase? Will the future earnings provide sufficient free cash flow to pay a dividend? What other obligations, such as debt, might absorb future cash flows? Is management committed to growing the dividend? Would you buy this stock today as an income investment? This step determines if the stock is a candidate for a sale. The next step asks the critical question...
II. Are There Better Alternatives Available?Once the stock has been identified as a candidate for a sale, the question then becomes is there something out there that is better? Don't forget in determining the market value of a stock, the market considers any known "bad news" about a company. So after the bad news is out and the company freezes the dividend, the price may drop and increase the effective yield on the stock. Yield on cost is not relevant when considering a sale.
The current price and current yield are what you will receive and give up when selling a stock. With the cash received is there another stock that would be an "upgrade" from the one you are selling? What does its future prospects look like? Will the new stock replace the dividend income lost from the one sold? What does its debt and cash flow look like? Will it continue to grow its dividend in the future? Is it a more riskier stock?
If in answering these questions you determine the stock should be sold, then you pass step two. At this point, you should sell the stock that failed to raise its dividend and purchase the one you identified in step two.
A Real-World ExampleI am holding a stock in my dividend growth portfolio that has not increased its dividend for more than a year. It is:
Intel Corporation (INTC) is the world's largest manufacturer of microprocessors, the central processing units of PCs, and also produces other semiconductor products. INTC's dividend has been flat since August 2012. The stock is currently yielding 3.0%.
Let's run it through the two-step process and see what happens:
I. Does The Stock Still Meet Our Investment Criteria?
Can the company raise its dividend, albeit late, and still preserve a year-over-year increase?
Yes. INTC's dividend in 2013 was $0.90 per share ($0.225 x 4). For the first three quarters of 2014 it has continued to pay $0.225 per share. Any increase in the fourth quarter will push its 2014 dividend above 2013.
Will the future earnings provide sufficient free cash flow to pay a dividend?
With the decline of PCs and a weak mobile presence, INTC has struggled some as the world has moved to tablets and smart phones. However, its core business is still producing strong free cash flows.
What other obligations, such as debt, might absorb future cash flows?
At 19%, INTC has a very strong debt to total capital position. There are no other pressing needs for immediate cash infusions. Also, with a 53% free cash flow payout, INTC is well-positioned to raise its dividend in the forth quarter.
Is management committed to growing its dividend?
In 2013 the company paid less than $5 billion in dividends. At the end of June 2014, INTC had $7.5 billion of cash and short-term investments on its balance sheet. Is management committed to growing its dividend? This is subjective, but given the above, I would say management is not committed to growing its dividend if it does not raise it in the fourth quarter.
Would you buy this stock today as an income investment?
I would not buy INTC today as an income investment.
Based on Step I, INTC could be a candidate for a sale if it fails to raise its dividend in the fourth quarter. Let's INTC through step 2.
II. Are There Better Alternatives Available?At 2.6%, INTC has a decent, but not spectacular yield when compared to other stocks in my dividend growth portfolio. Alternative stocks yielding between 3.0% and 7.3% in my database include:
- Johnson & Johnson (JNJ) Yield: 2.8%
- Exxon Mobil Corporation (XOM) Yield: 2.8%
- Pepsico, Inc. (PEP) Yield: 2.9%
- Cisco Systems, Inc. (CSCO) Yield: 3.0%
- Coca-Cola Company (KO) Yield: 3.1%
- Procter & Gamble (PG) Yield: 3.2%
- HCP, Inc. (HCP) Yield: 5.2%
- AT&T Inc. (T) Yield: 5.2%
- TC Pipelines, LP (TCP) Yield: 6.3%
- Main Street Capital Corp. (MAIN) Yield: 6.4%
You will note that some of the companies are Master Limited Partnerships (MLPs), Business Development Corporations (BDCs) and Real Estate Investment Trusts (REITs). These have increased tax implications since they do not pay income taxes as an entity. Thus, much of the higher yield is attributable to their tax situation.
As for the other Step 2 questions:
- What does its future prospects look like?
- Will the new stock replace the dividend income lost from the one sold?
- What does its debt and cash flow look like?
- Is it a more riskier stock?
- Will it continue to grow its dividend in the future?
As noted above, INTC is trying to gain a larger share of the mobile market, where most of the future growth will occur. There are several candidates that could easily replace INTC's income at equal or lower risk. In this particular instance, I will likely sell my INTC position if it does not raise its dividend in the fourth quarter.
Full Disclosure: Long INTC, JNJ, XOM, PEP, CSCO, KO, PG, HCP, T in my Dividend Growth Portfolio and long MAIN in my High-Yield Portfolio. See a list of all my dividend growth holdings here.
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