When to Sell an Underperforming Dividend Stock

brianoconnell

With the Dow Jones Industrial Average mounting a slow and steady comeback in late July (the DJIA stands at 26,600 after sliding to 21,000 in mid-March), more investors are taking a closer look at their portfolios as stocks solidify their value after a brief slump.

If you’re reassessing your stock holdings and wondering what to do next, a good place to start is figuring out when it’s a good time to dump and underperforming stock – especially dividend-paying stocks.

We checked in with Daniel Kent, founder of Stocktrades.ca, a Calgary, Canada-based online investment platform and asked him the top “warning signs” indicating it’s time to deep-six an underperforming dividend stock.

Here’s what Kent had to say:

“There is a multitude of factors that can indicate it's time to let go of an underperforming stock, but the question is heavily dependent on what type of stock you're looking at. In terms of stocks that pay dividends, I look at two key factors when I am thinking about selling:

--- A cut of their dividend. This is quite possibly the knife to the heart of any dividend investor, and I actually almost experienced this first-hand with a Canadian company called Altagas. Last year I sold just prior to the cut because I knew the dividend was unsustainable and they had just made a horribly overpriced acquisition. The stock fell over 50% in the six months after I sold the stock.

The main signal of a potential dividend cut? The companies payout ratio. I typically avoid companies that payout over 65%, but anything over 80% should be sounding alarm bells.

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--- The stock is overpriced. Dividend companies tend to bloat in terms of value simply because a purchase in the company will give you an immediate reward, its dividend. These stocks also tend to perform better in weaker markets because of the fact they pay a dividend.

There is no shame in taking profits on a dividend company and simply reinvesting when the price inevitably falls.

--- Economic factors. For example, if oil is tumbling, even though you've fallen in love with the oil and gas stocks you own, it may be time to let them go.

I had a very hard time doing this when I started out, but there will be opportunities to buy in again later. Some investors simply choose to ride out the storm and possibly dollar cost average their way down in overall share price.

I simply choose to take my profits and come back to the company when the outlook is better. In terms of growth stocks, there are a bunch of signals, but there are two in particular that should have you running for the hills.

· First is fundamental stress. Unlike a dividend company, who for the most part has established the formula for successful business operations, growth companies are still finding their way. Because growth companies are typically significantly overvalued relative to their earnings (or losses) stress in the fundamentals of the company such as cash flows, sales or debts can cause a significant shift in stock price. That’s why it is absolutely crucial to be on top of the quarterly earnings of growth stock companies.

· Second is slowing growth. This one may be obvious, but people often confuse this with completely stalling growth. It's very important before you even purchase a growth stock to take note at how much you're paying for expected future growth. If a company has a compound annual growth rate of 30% over the last three or four years, the stock price is going to be bloated. 

If that growth slows down to 15%, most investors would still be more than happy with it. But whether or not you're happy doesn't change the fact you now own a significantly overvalued stock, that is inevitably going to free fall.