Never Sell A Blue-Chip Stock That Drowns You In Dividends

When I receive e-mails from people who have come across this blog and want to discuss portfolio strategy, I’ve found that a good chunk of readers have taken to a dividend growth strategy even if they would not articulate it as such.

The impetus for writing this article came from a reader who said (in my paraphrase), “Yeah, I’ve held Coca-Cola, Johnson & Johnson, and Colgate stock which you talk about a lot. I’ve had it since 1992. I didn’t really see the point in selling it because the dividend kept going up.”

Once you have one of the top businesses in the world on your household balance sheet, it doesn’t really make a whole lot of sense to sell it. A well-picked dividend stock is like your own little money well, your own little cheat that makes life easier, your own little ATM machine that dispenses money four times per year, and either charges you a “fee” of 0% or 15% or so depending on the tax structure in which you choose to keep the asset.

Heck, even Warren Buffett for heaven’s sake, seems to make his mistakes when it comes to selling a blue-chip stock too soon. In 1966, Warren Buffett put a couple million dollar’s worth of the Buffett Partnership assets into stock of The Disney Company. He paid 31 cents per share, and then sold the company at 48 cents per share once he concluded that the stock was fully valued. Yeah, it’s definitely making over 50% on your investment within a year, and at the time, it’s easy to see why you might want to sell a stock after such a quick, rapid increase.

But here is the thing. If Buffett simply held on to the stock, it would have continued to compound at 12.31% annually since then. I’m not sure exactly how much money Buffett put into Disney, but let’s stipulate that it was $2.5 million back in 1967. Since then, that investment in Disney would have turned into over $391 million (although the results would have been lower when you account for taxes). Of course, in Buffett’s case, you could say he made the rational decision—for a guy who has compounded wealth at 19% or so annually since then, it’s fair to say he has done better than the 12% annual returns offered by Disney.

But for us mere mortals, a 12% annual return is a rocketship that takes us to financial independence in a hurry. Even with Disney’s puny 1.22% dividend yield, the initial Buffett investment would be paying out $4.7 in annual dividends today. Disney isn’t even really a dividend company—it spends 4-5x as much doing share buybacks as paying dividends (something I find slightly lamentable now that shares are slightly overvalued).  And still, forty-six years of compounding cause even puny dividend payers to put you in the position of receiving almost twice your initial investment in dividends paid to you every year.

I think that investment mistakes start to happen when you willingly relinquish your ownership stakes in companies that you believe have 90% or greater chance of raising their dividends each year into the indefinite future. When you own companies that function as ATM machines four days per year that give you annual raises, it doesn’t make sense to sell them at $60 simply because you believe they are worth $50. Let the company grow its profits for a year or two, and then it will legitimately be worth over $60 per share, and you’ll get to keep your hands on the income stream.

That’s why you should think of portfolio construction as laying a foundation to a good financial house. Each stock acts a brick of sorts. A little Exxon here, a little Nestle there. A little Procter & Gamble over there, a little Emerson Electric in that corner. It should primarily be an accumulation exercise rather than a rental exercise in which you trade into and out of stocks in the hopes of getting high prices.

Yeah, when Coca-Cola trades at 50x earnings like it did in the 1990s, it’s okay to sell. That’s one of the few exceptions. Once a large-cap, non-cyclical stock has an earnings yield below 3%, it can be wise to sell because then, you truly are giving gains away.  But, otherwise, if a stock is overvalued, let the profits grow into the company. I think Wal-Mart has only failed to increase profits per share one year during my lifetime. The dividend keeps going up and up. Why would you give up a company like that? When you have money to invest, you buy the company and let it do its thing, which is keep giving you more and more money with each passing year. Then, when you get new money to invest, you find another company with the similar characteristics. Once you do these steps repeatedly twenty or thirty times, you will find yourself owning the most dominant enterprises in the world, and you will have diversified sources of the highest-quality companies in the world giving you your share of the profits. Why screw around with that?