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May 27 2011  / Strategy Article - Dividend Invest / Dividend Cut

Dividend Stocks That Cut Dividends

PART 2 - The Long Term Dividend Investor

PART 3 - Strategies For The Dividend Investor

PART 4 - Buying Puts For Protection

PART 1 - Are They Good Buys?

 

 

 DIVIDEND STOCKS THAT CUT DIVIDENDS - PART 2

 

INTRODUCTION

 

In Part 1 I looked at a dividend investor who buys a large cap dividend stock after the announcement of the dividend cut is made. In Part 2 I will look at the buy and hold investor who has created a dividend stock portfolio and has been in the stock for 10 years and rather than being dismayed at the dividend cut looks at it as a long term opportunity. Is such a dividend investor correct? Let's use our theoretical study once again and this time try to determine the best of course of action for a long term dividend investor who has had his dividend stock portfolio damaged by the dividend cut.

When a stock stock makes a cut, it almost always means the company is in trouble. Theoretically speaking many long term investors would consider the best course of action is to leave the stock. But what about a big behemoth of a stock such as General Electric, Wells Fargo stock, Citicorp stock? All of these companies (and many more) cut their dividends dramatically in the bear market collapse in late 2008 to early 2009.

Let's go back to our General Electric stock and try to determine what a long term dividend investor might consider doing. Stocks like General Electric have been on the stock market for decades. These are giants in their own industry with literally tens of billions in sales. Therefore one thing a dividend investor knows is that unlike stocks such as WorldCom or Enron, stock like GE have been in existence for a very long time and should, in all likelihood continue to stay in existence.

 

With that being the case, a long term dividend investor might look at a decline in stock value as an opportunity to add to their dividend stock portfolio. However when a dividend paying stock cuts its dividend, the loss is two fold - capital depreciation leading to substantial investment losses especially if the investor should sell at a time of loss, and the loss of income through the dividend cut.

 

Let's go back 10 years and view a number of different strategies a buy and hold investor or dividend investor could consider. No commissions are taken into account for any of the trades shown here.

 

STUDY 1: THE LONG TERM HORIZON DIVIDEND STOCK BUYER

Many long term dividend investors are just seeking the highest paying dividend stock or highest yield dividend stock. Many such investors set up a basic plan to average themselves into the stock over a period of many years. They do not have a complex dividend investment strategy. This is the same simple strategy that many mutual fund investors or ETF investors take. Other investors use a dollar cost averaging in strategy. There is not a lot of dividend investment strategizing here, just a simple buy, collect the stock dividend and buy again. This will be our first study.

 

If an investor had bought 100 shares of GE stock at the close on the first trading day of January of each year here is what the investment in General Electric would look like as of May 27 2011, (the time of writing this article):

 

JAN 2 2001 - $43.75 = $4375.00  - Dividends Earned To Date - $852.00

JAN 2 2002 - $40.95 = $4095.00  - Dividends Earned To Date - $786.00

JAN 2 2003 - $25.48 = $2548.00  - Dividends Earned To Date - $713.00

JAN 2 2004 - $31.12 = $3112.00  - Dividends Earned To Date - $636.00

JAN 3 2005 - $36.59 = $3659.00  - Dividends Earned To Date - $554.00

JAN 2 2006 - $35.37 = $3537.00  - Dividends Earned To Date - $463.00

JAN 3 2007 - $37.97 = $3797.00  - Dividends Earned To Date - $360.00

JAN 2 2008 - $36.76 = $3676.00  - Dividends Earned To Date - $276.00

JAN 2 2009 - $17.07 = $1707.00  - Dividends Earned To Date - $121.00

JAN 2 2010 - $15.13 = $1513.00  - Dividends Earned To Date - $62.00

JAN 3 2011 - $18.28 = $1828.00  - Dividends Earned To Date - $14.00

 

TOTALS: 1100 shares 

TOTAL CAPITAL INVESTED: $33757.00  / 1100 shares = average share price - $30.69

Dividend Income Earned since Jan 2 2001: $4837.00

STOCK COST BASIS: $33757.00 invested less $4837.00 in dividends = $28920.00 / 1100 shares = $26.29 per share

 

After being in GE stock for 11 years, if sold today (May 27 2011) the loss on the total investment would be $19.47 X 1100 shares = $21,417.00 minus the dividends earned for a cost basis of $28920.00 which results in a loss of $7503.00 or 25%.

After 11 years of being in the stock the dividend investor has lost 25% of their capital AFTER dividends are taken into account.

 

If you set aside dividend payments it is even worse, with a total capital loss of $12,340.00 or 36%. This would spell disaster for many dividend stock portfolios.

 

STUDY 2: BUYING MORE SHARES AFTER THE DIVIDEND CUT

Taking the above figures and totals, what would happen if the long term investor decided to purchase shares the day after the dividend cut was announced. Looking at the chart below, GE stock closed during the stock market panic on March 2 2009 at $7.60. The next few strategies are based on a dividend investor adding more stock to his dividend stock portfolio the day after the dividend cut.

 

 

Here are some samples of what might have happened:

A) Buy 100 shares at $7.60

This would mean a capital investment of $760, which when added to the original amount invested of $33757.00 equals $34517.00 which divided by 1200 shares equals a cost basis of $28.76 before dividends.

 

B) Invest 25% of the original investment into GE stock

Original invested amount equals $33757.00 which for 25% would add an additional investment of $8,439.25.  This would mean the dividend investor would purchase 1100 shares of General Electric Stock at $7.60 for a total outlay of $8360.00.

The investor would now have $42193.00 invested in General Electric stock. The cost basis on the stock would be $42,193.00 / 2210 shares = $19.17 before dividends are taken into account. This though would require a considerable increase in their dividend stock portfolio. It also means they have invested over $8,000 in a dividend stock that is paying a very small dividend. At 10 cents on $7.60, the return is 1.31% annual. This is certainly not the highest paying dividend stock.

 

There are lots of variants an investor could consider including using 10% or 15% of the original investment as the amount they would be willing to risk in General Electric Stock. As you can see though, by selecting 25% an investor has reduced his cost basis considerably in the stock. This means that the dividends earned to date and all future dividends are not being considered to reduce the overall cost basis in the stock. However if an investor had $100,000.00 already invested in GE stock, they may not be pleased to have to invest another $25,000.00. Consider an investor who may have $250,000 invested in GE stock. Would they wish to risk another $62,500.00 at the height of a stock market panic or market meltdown?

 

C) Buy More Shares Looking For A Quick Capital Gain

This brings up the possibility of strategy C. The investor takes 25%, buys GE stock at the close of business on the day after the announcement of the dividend cut, but with the full knowledge that they intend to sell that stock for a profit should GE stock recover. This then means the investor is risking his capital, but upon a recovery, the investor will sell that stock and the capital will be returned with a profit and the initial investment in GE Stock prior to the dividend cut will remain intact. This would perhaps have the least long term impact on a dividend stock portfolio, but there is still risk.

I will not show figures for this strategy as the selling point would have to be determined by the investor. After purchasing shares for $7.60, they might sell those shares at $10.00, $12.00 or even $14.00. Each price difference would affect the amount of profit and the cost basis of the original investment.

 

SUMMARY

While these strategies could work for a number of dividend stocks, would this type of strategy work for every large cap dividend stock that has a dividend cut? No, because there is never a guarantee that a stock that has collapsed will in fact recover and reinstate its dividend. Citicorp stock, AIG stock and others can destroy a dividend stock portfolio.

The problem with investing just for dividends is, there is no guarantee the dividend stock will continue to make payments and increase those payments. When a dividend investor risks capital for 3%, 4%, 5% or even 7% annual dividend payments, the collapse of a single dividend stock and a dividend cut, can damage a dividend stock portfolio. That damage can take years if not decades to recover.

So are dividend stocks that have a dividend cut, good buys? I believe they are, but only for investors who are stock traders. Long term dividend investors I think, need to consider a number of different strategies, which is the focus of Part 3.

 

In Part 3 I will present a number of different strategies for dividend investors to consider when investing and when a dividend stock has a dividend cut. These approaches to dividend stock investing may never have been considered by dividend investors..


INDEX

Dividend Stocks That Cut Dividends

PART 1 - Are They Good Buys?

PART 2 - The Long Term Dividend Investor

PART 3 - Strategies For The Dividend Investor

PART 4 - Buying Puts For Protection

 

Disclaimer: There are considerable risks involved in all investment strategies. Trade at your own risk.
Stocks, options and investing are risky and can result in considerable losses. None of the strategies, stocks or information discussed or presented are financial advice, trading advice or recommendations. Fullyinformed.com is a private website. Everything presented and discussed are the author's ideas and opinions only.
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