Do You Sell After A Dividend Cut?

As dividend income investors we ultimately choose our investment thesis primarily based on the state of the dividend payments that a particular company distributes. We check for sufficient current yield, dividend growth, sustainability and history of dividend distributions before we make an actual investment. Once we finally do pull the trigger and initiate a dividend stock purchase, we begin thinking about our projected income stream the new dividend stock will provide in the current and coming years. After all, our primary reason for investing in dividend stocks is to create an ever increasing income stream to supplement or fully fund our retirement years, whether it occurs at age 40, 50 or 60, the goal remains the same.

 

But what happens when a dividend stock you purchase cuts its dividend? Do you sell after a dividend cut? I know many dividend bloggers outline their criteria for investing in dividend stocks, among them an automatic ‘sell’ of any stock that has cut its dividend. But is this always the most prudent thing to do? I have always held the belief that any stock needs to be analyzed in a multifaceted manner. Just as I have typically written in many posts that a low PE alone does not a good investment decision make, neither does simply looking at a dividend cut as a simple black and white decision to sell a particular stock.

 

Companies often do not cut dividends out of the blue. Rather, several months of foreshadowing typically occurs before the dreaded cut. As investors for the long term we often tend to hold onto potential losers for fear of losing out on future dividend income. But, when it comes to dividend cuts one must ask several questions before actually unloading the stock.

 

First, one must ask if the reason for the dividend cut is a result of a systemic financial crisis such as experienced in 2008 and 2009. Many great companies were forced to temporarily cut or eliminate dividend payments simply because of unprecedented market conditions. But, as market conditions slowly improved and a general up tick in the domestic and global economy gained momentum dividends were reinstated and stock prices appreciated. Selling quality stocks that have slashed dividends simply because of rough economic times would equate to bad market timing as you would have sold at market lows.

 

Second, one must examine if there is a fundamental shift in the industry where a particular company has cut its dividend. You must always ask yourself the question of whether the company/industry is broken or is the stock broken. Of course, in the case of the former, a stock sale may be warranted as industry and company metrics may be fundamentally broken when there is an overall decline in the sector. Think of Kodak and the demise of film cameras. That industry as a whole was broken and not just the stock of Kodak. However, in the latter case, you might just have a broken stock in which case a buying opportunity may be presenting itself as industry and company fundamentals remain sound but only stock performance is broken. Think of McDonald’s Corp. (MCD) about ten years ago when the quick serve restaurants were still experiencing tremendous growth but the stock of MCD was broken and trading in the low teens. Though it wasn’t a dividend cutter, in 2004 you would have had an excellent buying opportunity in a great industry with a broken stock.

 

Third, one must consider the prospects of jettisoning historically high quality dividend paying companies simply because of a dividend cut and incur additional trading fees. An indirect benefit of dividend investing is that you inherently trade less frequently and thus save on commission costs. Studies have shown that trading in and out of stocks too frequently incurs the added expense of trading fees and often does not perform any better than buying and holding for the long run (even after a dividend cut). The very nature of investing in high quality dividend payers, by default, means you have an investment that is solid, reliable and predictable so why would you ever want to sell a position that possesses these qualities? Often companies that possess these high quality metrics reinstate their dividends and return to a policy of dividend raises coupled with capital appreciation.

 

Real World Example

 

Some examples from my real world portfolio that have experienced dividend cuts include investments in General Electric Company (GE) , Wells Fargo & Company (WFC) and Ingersoll-Rand Plc (IR). In each case dividend cuts were drastic and was expected during the financial meltdown in late 2008 and 2009. I knew that the financial sector was in shambles and could tell that GE, especially back then, was very reliant on its financial division for its revenue and profits and was deeply impacted by mortgage losses like any other “standard” bank such as WFC. Though a solid dividend payer with a very friendly dividend policy I could see the writing on the wall with my WFC investment as well. In a similar fashion, though not a bank, I could see my investment in IR was also in danger of a drastic dividend cut as many industrial companies experienced tremendous slowdowns in new orders and overall revenue.

 

What did I do? I simply stuck to my dividend investing criteria and simply kept investing in each of the three companies despite a huge loss in stock value and dividend income. To me the notion of selling companies that I felt very strongly about and did not see an inherent weakness in their overall business operations or industry they were in seemed foolish. During those dark hours I could see the light at the end of the tunnel and that there would be a world with a GE, WFC and IR five, ten and even twenty years down the line. These were simply broken stocks and not broken industries. After all, the world is still very reliant on GE products, financial instruments from WFC and industrial goods via IR. In fact, each of the three companies have been raising their dividends, once again, for the past several years and IR even completed a spin off of its security business as Allegion plc Ordinary Shares (ALLE) which also pays a dividend. You can be certain, had I sold each of the three stocks, simply because of a dividend cut, I would have certainly missed out on some great capital appreciation and rising dividends. In fact, my GE holding is up about 20%, my WFC holding is up almost 60%, my IR holding is up over 120% and my spin off of ALLE, which did not cost me one dollar, is up over 155%.

 

The moral of the story is that dividend income investors should not simply equate a dividend cut with a stock sale. Dividend cuts alone do not necessarily show that a business is likely in trouble. You must examine all the reasons for the dividend cut and see if there is something fundamentally wrong with the company and/or sector it is in, or is the cut simply a temporary solution to a money crunch that a company is experiencing while the overall industry it operates in remains sound. Blindly selling stocks because of a dividend cut may not be the best solution for an overall dividend income portfolio.

 

Are dividend cuts an automatic ‘sell’ for your portfolio holdings? Please let me know below.

 

Disclosure: Long GE, WFC, IR, ALLE, MCD

43 thoughts on “Do You Sell After A Dividend Cut?

  1. Nice discussion DH. The other instance I’d definitely keep a dividend cutter……conserving cash while making a strategic acquisition. While I prefer organic growth to acquisitions…..IF the company’s underlying business hasn’t changed, AND they cut a dividend to avoid taking on debt (or issuing shares)……then I’m not opposed. Any cut gets my attention, and warrants a deeper look.
    -Bryan
    Income Surfer recently posted…Will You Encourage Your Kids to Attend College?!My Profile

    • Hi IS,

      There’s no question that a dividend cut definitely warrants some much needed attention. The point of the article was to highlight that a dividend cut does not always equate to a stock sale. As you mentioned, if the business still hasn’t changed and the cut was to conserve cash in order to avoid further dilution then the situation is not as bad as first seemed. The bottom line is that a total picture must be viewed when deciding to ultimately jettison a stock. Thank you for stopping by and commenting.

  2. Hi Divhut,

    Fortunately I’ve never dealt with this situation before. However, I do have my strategy ready.

    If the company is reducing their dividend to zero, it’s an instant sell basically. This happened to the biggest telecomminication firm in The Netherlands. They didn’t change their strategy to mobile internet in time, once text messages became obsolete due to Facebook and Whatsapp. A very costly mistake. Their stock price is plumming nowadays, with huge dividend cuts as a result.

    If the company is just reducing their dividend, it is certainly not a good sign, but worth a closer look in my opinion.

    Best wishes, DfS
    Dividend for Starters recently posted…Income & expenses – August 2014My Profile

    • Hi DFS,

      You hit the nail on the head. If a dividend cut or elimination is the result of a fundamental change in the business/industry then I agree a stock sale is warranted as was the case in your example regarding a slow strategy shift to mobile internet for the telecom company you mentioned in the Netherlands. It’s definitely not a black and white decision and I feel that many bloggers automatically sell great companies simply because of a dividend freeze or cut. I think that is wrong. Thank you for commenting. I appreciate it.

  3. Wow, this is one heck of a timely article! I’m just writing my investment plan for the first time (should be posted this week), and my only sell criteria are a) on a dividend cut, or b) a freeze lasting more than 8 quarters. My reasoning can be summarized by one word: inflation. If inflation is 2% a year or whatever, I want my dividend income to exceed that, especially when I don’t have a normal income to support me. A dividend cut makes it that much harder to exceed inflation, and rather than eventually having to sacrifice my lifestyle, I’d rather rotate into a stock that still grows its dividend payment. Granted, this may not be an issue the more positions I hold, but every bit helps.

    • Hi DD,

      I guess great minds think alike. While you bring up a valid point regarding inflation and the need for current dividend income, you must always question the overall health of a stock you are considering to jettison. From my real world example, I would have been pretty unhappy selling my GE, WFC and IR at the lows of 2009 only to see dividend payments increase in the coming years along with great capital appreciation and even a stock spin off. This is why we create a portfolio of many dividend paying stocks to protect against a potential freeze or reduction in dividend payments. The point of the article is to highlight that not all dividend cuts are created equal. A company cutting a dividend with a payout ratio of 150% might be expected but if great companies that aren’t experiencing any industrial shifts with low payout ratios, such as GE and WFC, cut their dividend, you can expect it to be a temporary fix to a temporary financial situation. Thank you for sharing your opinion.

  4. Hi DivHut,

    From 2004 until early 2011 I had been investing directly into GE through a DRIP. I held on to them through the financial crisis and subsequent dividend cut. However, in late 2011 I decided to cut my losses and consolidate the direct GE investments into a single brokerage firm to make things easier to manage.

    Yes, if I would have held on until today I would have been ahead in terms of dividends and # of shares held, however, my cost basis was in the 40s and overall I would still be holding GE at an unrealized loss even today.

    Instead, I used the funds freed up from selling GE to buy other beaten down stocks, like WFC. WFC has recently performed even better than GE, and I am way ahead from where I would been if I held GE.

    I don’t sell often, but when I do I always ask myself if there’s a better place to put the money. If there is, like the case of GE in 2011, then I sell, otherwise I hold and maybe buy more. (I also did repurchase GE in 2013 and will likely be holding onto it for the long-term now.)
    Scott recently posted…Investing in WaterMy Profile

    • Slight correction: my cost basis was in the mid-20s. Not counting dividends I’d be about back to even. However, the money still performed better since I moved it to WFC.

    • Hi Scott,

      You bring up a good point about opportunity cost. Can money in one investment perform better in another? Ultimately the answer can only be given in hindsight. As with your example, moving GE money into WFC proved to be a better choice when deciding among the two. Instead of deciding I chose to continue to invest in both GE and WFC averaging down my total cost as well as continued to collect dividends, albeit smaller dividends after the cut. It can be interesting to play the “what if” game and see how you would have performed if you simply kept your GE stock and continued to add to it all during the downturn and dividend cut. Your point simply highlights what I am trying to convey among dividend investors is that dividend cuts are not always a clear and easy sign for you to sell a stock or shuffle money around. It’s always a unique situation that must be examined carefully and not be the result of a simple cause and effect reaction. Thank you for sharing your personal experience and commenting.

  5. For me a cut is not an automatic sell and it really depends on what the economy is doing. I’d have forgiven companies a lot more for cuts during the great recession, although if it’s out of the blue in the current market environment I’d be more tempted to sell. Another thing that might keep me invested is management’s explanation. For example, DE announced late last year or earlier this year that they’d be keeping the dividend the same but gave a reasonable explanation for the freeze. The business environment was expected to be rough for them for the next year or two so they wanted to conserve cash. Completely understandable and very transparent. And earlier this year they gave a solid 10%+ increase. A full on cut to zero would probably lead me to try and sell pretty quickly but if it’s a freeze or reduction but there’s a good explanation from management then I’d be more inclined to hold on.
    JC recently posted…Weekly Loyal3 PurchasesMy Profile

    • Hi JC,

      You echo a lot of my sentiments regarding dividend cuts or freezes. You have to look at the whole picture before deciding to sell an otherwise great long term investment simply because of a freeze or cut. Your example with DE highlights a reasonable explanation from management as to why they have decided to hold their current distribution at the same rate as before. To me this sounds like a good reason to stay long DE. You seem to have a good grasp regarding dividend cuts and realize that a cut doesn’t equate to an automatic sell. Thanks for sharing a real life example with us and stopping by.

  6. DivHut,

    The dividend cut usually comes after all hell has already broken loose. Most stock prices will have already been taken to the woodshed by the time management kills the sacred cow, the dividend. A dividend cut might at actually be a contrarian indicator and could be a buying opportunity.

    MDP
    My Dividend Pipeline recently posted…Stock Purchase: MATMy Profile

    • Hi MDP,

      A very interesting take on a dividend cut. With regard to companies you really believe in and are in an industry that is not experiencing a global altering shift your comment on calling a dividend cut a contrarian indicator may hold true for many high quality companies. That certainly was the case from my real life example of GE, WFC and IR. Each company bounced back very nicely since cutting their dividends and illustrates the contrary view you mention. Thank you for stopping by and commenting and sharing this interesting take on a dividend cut.

  7. It depends on the situation. I kept Manulife after they cut the dividend. It was tough during the financial crisis but by holding on, I continued receiving the dividend and the stock has since recovered. If you can invest the money elsewhere and get a better return it would be worthwhile to sell.
    Tawcan recently posted…Recent Buy – TelusMy Profile

    • Hi Tawcan,

      Your experience with Manulife echos my experience with GE, WFC and IR. It was tough to see the dividend get cut and price drop precipitously but like you the stocks eventually bounced back and I continued to receive dividends in the meantime. The problem with selling high quality companies, even if you think you have found a better place to invest, is that you ultimately lock in sale losses and as mentioned in the article you essentially are selling a stock at price lows. If the company is a solid long term prospect and you still believe in your investment thesis, that gave you reason to buy in the first place, you might be better off simply holding onto the stock that has cut its dividend. Thanks for sharing your dividend cut experience and commenting.

  8. DivHut,

    I do not automatically sell when a dividend is cut. Sometimes it is the right thing to do like this mortgage REIT I owned and constantly was cutting the dividend. That was the only stock that I let get called away on a covered call scenario. A successful example was when I bought ERF the dividend was likely to be cut, but I enjoyed it for a couple months. Then it got cut right in half and the share price dropped significantly. Instead of selling it I had a feeling the company would find a way to turn itself around so I bought more I think in $13’s. Now the dividend has not increased, but the share price has done well and the dividend coverage has improved.
    Dividend SWAN recently posted…New Milestone! 30K PageviewsMy Profile

    • Hi DSWAN,

      Thanks for sharing your personal story with ERF. Your story highlights that even stocks that do cut their dividends may still be good long term holdings for a dividend income portfolio. While dividend income may be reduced, capital appreciation is more than likely if the company is still sound. As My Dividend Pipeline put it, a dividend cut for solid companies may simply be looked at from a contrarian perspective as often those companies bounce back quite strongly as was in my case with GE, WFC and IR. Happy you stopped by!

    • Hi Allan,

      Hope my post shed some light on dividend freezes and cuts. MAT has been an interesting stock as of late with a yield north of 4%. This is not a normal yield for that stock and a cut may be imminent. I guess time will tell. Bottom line, every dividend cut should be looked at individually and not simply be a cause and effect reaction in terms of selling dividend cutters. Thank you for stopping by and commenting.

  9. Hi there, DivHut,

    I don’t think I’d automatically sell for a dividend cut, but I COULD sell after a dividend cut. If a company increased its EPS and cut dividends, I’d think twice about holding on to it, because I’d feel that meant management wasn’t respecting its owners. If a company hit a rough quarter and cut dividends to stay in line with payout ratios, I’d probably stick with it (if I still believed in the company).
    CharlesMakesCents recently posted…Buying Full-Time FreedomMy Profile

    • Hi CMS,

      The bottom line with this question every dividend growth investor must ultimately face at some point is that it depends on whether to sell or hold on to a particular stock. In other words, there is no black and white clear cause and effect methodology one should follow simply because of a dividend cut. Too often I read about other dividend bloggers who simply hit the ‘sell’ button once a cut has been made. This is wrong on many levels and one might even take a contrarian view after a cut is made and use it as a signal to buy when others sell. Thanks for sharing your point of view and commenting.

  10. Hi DivHut,
    I’ve not a dividend investor (yet) as I’m currently concentrating on funds, Investment Trusts and ETFs but I was interested to read about your strategy. The people who make good investors do seem to be those that really do their research before they commit to buying and believe in what buy. This is obviously your approach too.
    (btw thank you for your words of wisdom on my blog :-))
    Cerridwen recently posted…September 2014 UpdateMy Profile

    • Hi Cerridwen,

      Your comment brings up another classic dividend investing topic… Is it better to buy individual stocks or buy funds? Personally, I chose the former and am happy thus far. As you indicated you primarily invest in funds, Investment Trusts and ETFs which is perfectly fine too. I think some people defend their positions in this debate quite fiercely. The key when selecting dividend stocks is to build a well diversified portfolio with constant dividend growers. Don’t chase yield and reinvest all dividends automatically to achieve better compounding. If you ever have any questions about my stock picks or portfolio holdings please feel free to comment or email. Thank you for stopping by.

  11. DivHut,

    As a novice dividend investor, I have not yet experienced a dividend cut, so thank you for your insightful article. One of my personal investing criteria is to sell an entire position if I think that either the business or its model is unsustainable in the long run. While a dividend cut stings, it’s often better for the company in the long run. As such, I don’t think I’d mind a cut too much, especially if it was a small one.

    The flipside of companies experiencing a dividend cut is that their price often drops, which opens up new buying opportunities if their long-term outlook remains great.

    Best regards,
    NMW
    No More Waffles recently posted…Savings Rate for September 2014My Profile

    • Hi NMW,

      I happen to agree with your premise regarding selling dividend cutters. It really depends on the overall business model of the company whether or not it is still sustainable. If not, it might be time to sell. If the business model still works but tough times fell on the company in question it may be wise to simply hold on. A few people who commented also opened up the case for buying stocks on dividend cuts, as you mention as well, because it may create a great buying opportunity as share prices often drop as a result of a cut. Thank you for stopping by and commenting.

  12. Hi DivHut,

    Like Cerridwen, my investments are mostly in funds but I recently decided I wanted to have a small portfolio of shares too, for a bit of diversification!

    I had just purchased my 3rd lot of shares when I was confronted with the “Dividend Cut” question – Tesco (TSCO) announced losses and a dividend cut! Of course, selling now would be silly, as I would immediately make a loss with the share price plummeting. So I’m just going to hang on for the long term, although I know it’s going to be a bumpy ride! In fact, I’m keeping an eye on things in case I feel tempted to buy more shares while they are so cheap – need to see what happens over the next few months or so!
    weenie recently posted…September 2014 Savings, Portfolio & Net WorthMy Profile

    • Hi weenie,

      Thanks for sharing your real world experience with dividend cutter TSCO. I know from the headlines that TSCO has been having some major trouble in many markets including foreign and domestic. I know from here in the U.S. their attempt with Fresh & Easy stores did not quite pan out as expected was deemed a failure. You may be right that with a dividend cut and falling share price that TSCO is a buy but I would still be careful before adding to my position. I appreciate your comment and stopping by.

  13. Great topic DivHut!

    PFE is one I owned that cut its dividend and I sold off shares. I wish I had held on, I think they have come back nicely also. I’ve learned a lot of hard lessons the last 5 years.

    • Hi AAI,

      Your story seems to echo many who have commented. They all wish they had not sold their shares in dividend cutters. In fact, the more I look into this topic the more I realize that dividend cutters are more of a contrarian play than a reason to sell. Seems like more often than not people who did sell a dividend cutter regretted the decision years later. Thank you for sharing your experience and commenting.

  14. DivHut,

    Interesting article. I like how you felt these institutions weren’t fundamentally incorrect – just it was time to real back in the dividends until they came through the crisis, survived, thrived and are back to pumping their shareholders to increasing dividends at a high rate. Can it happen again? would be my question.

    I have had 2 stocks cut dividends – one I sold right away, and it was the right decision (HCBK is still trading lower than when I sold it 3+ years ago). The other, I’ve held on as I want to see what management can do with their business model.

    So I have both scenarios obviously where I sold it and didn’t think anything could help the situation and held on to one where I think the situation can be fixed.

    -Lanny
    Dividend Diplomats recently posted…Bert’s September Dividend Income & Portfolio SummaryMy Profile

    • Hi DD,

      Your comment illustrates that having a rule to sell dividend cutters is not always the best methodology when managing a dividend stock portfolio. It really has to be a case by case basis as each company and industry they are in should be considered before unloading stock. I feel too many dividend bloggers have a cause and effect rule in place regarding dividend cutters and automatically sell any stock that freezes or cuts a dividend without looking at the whole picture first. At least from your perspective you have experienced both scenarios and kept one stock and sold another. The bottom line is that every case is unique and that a blanket rule to automatically sell dividend cutters is a mistake. Thank you for sharing your real world experiences and for stopping by.

  15. For me it depends on how many shares I own of that company. If not to many probably will wait and see. If allot then I would probably scrutinize the company and decide based on the information. Maybe wait a quarter to see if there is any improvement.

    • Hi DFG,

      I think it’s wise to look at each dividend cut on a case by case basis. Too many dividend investors have a blanket rule that dictates a stock sale must occur for any company that freezes or cuts its dividend. While I understand the premise behind this rule I feel that too often an investor ends up regretting selling the position as many dividend cutters resume dividend raises and experience stock price appreciation as well in the years that follow. Thank you for commenting.

  16. The key word for me in order to analyse a stock cut is ” is the company a solid blue chip company” If it is then the dividend cut could be explained and could be a short term event. Some investors only look at the dividend yield and buy with that high div in mind. Look at Atlantic Power and their div cut and resulting share price drop. They could not sustain that dividend payout. In that case I would sell, although I probably would not have bought in the first place.

    • Hi NRG,

      I happen to agree with your comment very much. I think too often investors are yield happy and forget other fundamentals regarding the sustainability of the dividend in the first place. Good example with Atlantic Power. I feel every cut must be looked at on a case by case basis and if the investment and business thesis remains unchanged, do not sell as I held on to my GE, WFC and IR shares despite the cuts. Thank you for stopping by and commenting.

      • Just seeing this great post today. Similar experience to NRG. Unfortunately I started in Dividend investing a couple yrs ago, not really understanding how to evaluate a company and ended up chasing yield, with EFC. In the last 12 months, they have cut the dividend twice, and the payout ratio is ridiculously high. Knowing what I know now, I would not have touched this stock. So everyday I am debating with myself on whether to let it go, since the stock price has gone from 23 down to 17, and would take a substantial loss if I did sell. Even with the div cuts, it still pays a good yield so that adds to my dilemma. I’ll do some additional research on why the dividend was cut, and make a final decision.

        • Hi Kenny,

          Many people when starting out as dividend growth investors get seduced by abnormally high yield. The general rule for dividend stocks is a yield somewhere in the low to mid single digits. Anything in the high single digits or double digits is asking for trouble. Of course, this is a general rule and certain companies like REITs or MLPs pay higher distributions. I built my portfolio by looking at the dividend aristocrats list first and made my buys from there, of course, looking at dividend growth rates, payout ratios, etc. What good is a dividend if it is not sustainable? My focus has always been on the dividend growers rather than the current high yielding stocks. So far, that has worked out quite well. Thank you for commenting.

  17. For me, it depends on the severity of the cut and my exposure to the stock. If the dividend cut is modest and the dividend accounts for a small portion of my total dividend income, then I will continue to hold the stock (optimism springs eternal…). But if the dividend stock is cut severely, then I will almost certainly sell off the stock.

    In my six years of dividend investing, I have only dropped a stock once because of a dividend cut. After WWE’s dividend was cut by 66% in mid-2011, I continued to hold on to it until early 2013 (and if I had waited a few months, I would have sold at a very modest profit). WWE;s dividend has not improved at all since I sold it off, and I’m glad I dropped it and put my money towards higher yield dividend stocks.

    • Hi DQ,

      Thanks for sharing your story about WWE stock and what you did after its dividend was cut. As you mentioned in your comment there is no black and white decision making process with a dividend cut as it all depends on which company cut the dividend and how severe it was. This was exactly my point when I wrote this article as I have seen many dividend bloggers have a set rule to simply sell any stock that cuts or even freezes its dividend. It should always be looked upon on a case by case basis. Thank you for stopping by and commenting.

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