Our favourite holding period is forever” – Warren Buffett
It is a fundamental tenet of dividend growth investing that you must be patient with your holdings in order to allow high quality businesses to compound your investment over time. This does not absolve you of the responsibility of monitoring your investments! One of the parts of my investment process that I continually struggle with is how to identify when I need to sell an investment.
Focusing on Price is not the key!
Although it is increasingly difficult for investors to take a long term and considered view of investments, it is vital that you understand that you have invested in a business, not a stock code with a constantly fluctuating price. Your job, as an investor, is to monitor the business performance in order to determine whether the business will continue to perform its compounding for your benefit.
Neither are quarterly sales or earnings numbers…
I monitor my holdings constantly, but a particularly good time to revisit your thesis on a stock is at the half yearly and full year results. Typically what I want to see is that sales are increasing (unless a division has been sold, for example) and that the company continues to pursue the same strategy as when the investment was bought. Typically these two factors are enough to drive earnings growth.
What I am not concerned about is management “missing” earnings. As I discussed in a previous post, a stock that is down 50% because earnings guidance is “just” 5-10% instead of 10-15% is a buying opportunity, not a selling opportunity.
Dividends are the Key.
The decision to cut a dividend for a company that has historically paid growing dividends is a large one, make no mistake. No matter what analysts say, no matter what ends up in papers or on TV, the dividend is a true test of a Board and management’s view of the future. This is particularly the case for a company that has historically paid growing dividends. Management are extremely reluctant to reduce dividends, as it is a signal of declining confidence in a stock.
The four questions I like to ask myself when evaluating a holding are:
- Is the dividend in jeopardy?
- An excellent example of a company that failed this test was BHP Billiton earlier this year. The company had a progressive dividend policy (each year dividend was to be higher than the previous years). Unfortunately, this implied that BHP would have to pay almost 250% of projected earnings in order to maintain its policy. This was a) unlikely and b) not sensible in any case.
- Has the company changed its policy?
- You should be very wary of a company which changes its dividend policy to be less favourable to shareholders. In my opinion, this should trigger an automatic review of your holding.
- Has the company failed to raise its dividend?
- This is the hardest question to judge. It is going to require some analytical ground work to determine whether the company has failed to raise the dividend for a specific and understandable reason, or if the company has been unable to raise the dividend. I would be very wary of a company which has not raised its dividend for two years.
- Has the company cut its dividend?
- If a company cuts the dividend for a company specific reason, you should almost certainly move on. There are many other potential investments in the proverbial sea! The only time where this may not be applicable is in a market wide downturn where companies are attempting to preserve cash – the GFC being an excellent example.
So when should you sell an investment?
In my opinion, holding your underperforming stocks is the most difficult part of investing! Whenever I get the urge to sell an investment, I ask myself: Is the investment providing the features for which I bought it? If the investment is still raising its dividend consistently, I aim to give the company ample time to compound my investment. However, if the company fails the questions outlined above, I typically sell investments when I believe their dividend stream is likely to be impaired.
You should try to find and hold dividend investments for the longest period possible. They are initially bought because you believe that the company you are part owner of will compound your investment, and as long as this is the case, you should sit on your hands and exercise patience. This does not excuse you from monitoring your investments, and as a dividend focused investor, you should focus on the dividend as a signpost for your investments. If the dividend is at risk, if the company is not growing, if the balance sheet or payout ratio is stretched, or the company cuts its dividend, you should consider finding a more attractive home for your hard earned investment dollars.
When and how do you decide to sell an investment? I’d love to hear your thoughts and ideas in the comments!