Mis-Steps on Dividend Stocks

Recently I started a dividend portfolio to try to capture a 3% – 4% yield since my CD’s had matured and I was tired of locking up money to receive a 1% interest payment.  The portfolio is over on the right and I summarize it here.

The “traditional” way to select stocks involves reading the annual reports, 10k and other SEC filings from that company. In general that is a lot of work and with disclaimers and confusing notes and footnotes and the “backwards orientation” of those reports I generally don’t learn a lot.

The first place I usually go when I am thinking of stocks is the “stock screener” over at Google Finance where you can put in criteria like market capitalization, profitability, yield, and stock price moves within a range of positive or negative and it will give you a list of stocks where you can start your search. Many of the stocks that pop up are ones I’ve already thought of but there are always a few surprises, especially the non US companies.

The next place I go are the general blogs like “Seeking Alpha” which have many articles on stocks. I would treat all of these with a grain of salt but they often spawn useful ideas that you can research on your own.

For another good source of information I go to the company’s web site and bypass the formal earnings files and look at the analyst presentations. These are power point slides (usually saved as PDF’s) that the company includes with their quarterly earnings call, or that the company provides analysts on “analyst day” when they meet and speak. Companies have to distribute the same information to all investors by SEC regulations (in general) so this is way to accomplish that, by putting it on the web.

I find these quarterly presentations to be very good. The company tries to be forward-looking, not backwards looking, and you understand the company’s motivation (to try to tell as rosy a story as possible). On the other hand, the company also has to temper their share holders’ enthusiasm, because high expectations by investors have to be backed up with strong results or the stock will likely be punished.

I didn’t do enough (or much of any) research with a couple of stocks I could have avoided a miss on – Exelon and Avon. Exelon (EXC) has seen its stock price come under fire, decreasing from around $44 to about $29 in a year, as investors assume that the dividend (currently 7%) is unsustainable. Here is a link to the EXC corporate events & presentations page where you can read their latest report that contains forward-looking information. While it is too late for me (I already bought the stock, saw it drop 20% in a heartbeat, and sold it, I will look at this presentation as if it COULD have helped me. It is the EEI investor conference in November, 2012.

That EEI presentation is densely populated with data and information and attempts to explain key, inter-related elements of Exelon’s business across multiple geographies. You gain a sense of how staggeringly complicated their business is. As someone inherently interested in energy and energy policy, I enjoyed reading it, and in some ways it is an elaborate document that describes how they intend to increase margins and efficiencies while deferring capital projects in order to 1) protect their credit rating 2) preserve their dividend. They don’t specifically address the dividend payout ratio in this document (anything above 70% of earnings isn’t sustainable in the medium term, and above 100% isn’t even sustainable long in the short term. Exelon is currently pretty far above 100%), on page 11 they have a projected cash flow statement for 2012 with “sources and uses of cash” and you can see that they have the dividend in at $1.75B and a beginning cash balance of $500M and an ending cash balance of $1.1B – but this also includes the cash contributed by the company they acquired so that one-time infusion is now gone.

While Exelon hasn’t reduced their dividend yet and the stock pressure is on because many analysts think they MIGHT reduce their dividend (and the company is attempting to publicly address the issue), Avon on the other hand DID cut their dividend and as a result the stock suffered an immediate loss. I lost 16% on that stock in short order. They don’t have the same types of forward looking PDF presentations on their web site, but tend to put more information in their conference call materials which include quarterly SEC information and margins, but doesn’t have much forward-looking information.

Avon does have a page here which showed WHY their stock was a long time favorite of dividend investors – go to this page where they showed their dividend history plus growth in the dividend over time back to around 1990. This pattern of steady growth of more than 5% / year is what attracted many investors to the stock and allowed them to include imputed forecasted growth in their projection for future stock values. However, Avon’s dividend proved unsustainable and this cut in dividends severely hit the stock price.

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4 thoughts on “Mis-Steps on Dividend Stocks”

  1. I think you are beating yourself up a bit AND have one other problem. First things first.

    I look at those large dips like Avon took and treat them as buying opportunities. I always ask myself “what has fundamentally changed within this company that made it worth 16% less than a few days ago?”. If I can’t figure it out I will look to either double down or maybe even get in.

    Example – Back a month or so ago, McDonalds recently announced a SLIGHT sales slowdown. The stock tanked from 90 to 85. I bought. From that ONE announcement, amid a flurry of great news from MCD, including their massive remodeling projects domestically and other good news the stock went down 5.9%. I again asked myself – has this company become 5.9% worse overnight? The answer is, of course not. I bought at 85 and it today sits at 88 after briefly hitting 90. I have also received a dividend payment in the meantime (current yield 3.4%). Try that type of performance with a CD.

    The second part of your problem is that you are WAY too short term focused. One quarter or one year isn’t even on my radar screen and if it is, that makes you a TRADER, not an INVESTOR. High dividend stocks of great companies are easy to pick, and when you have time on your side, it ends up being pretty easy. These short term stupid events like MCD above (I also bought when MCD tanked during the mad cow scare – remember that?) are nice buying opportunities to either get in for the long haul or to bring your cost basis down.

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  2. Your points are all valid.

    This is a weird portfolio for me. I had about 100k coming due in a CD and the yield I was being offered in my bond ladder (of sorts) was about 1%. So the purpose of this portfolio to me is “can I do better than 1% on interest, taking into account taxes, transaction costs, and the like on dividends in the equity market that is yielding about 3-4% for big stocks?”

    The answer is kind of yes. I did do better. But since the stocks are so damn volatile it became more of an equity strategy than a “return” strategy which wasn’t what I expected. Plus any gains I figured were dumb luck I might as well take it off the table.

    For Avon – I probably was just dumb. One of the big reasons they stink is that their CEO Jung keeps hanging around and stops the successor from making changes, good or bad, that could right the ship (or sink it). If she goes, then the stock might be ready for long term take off. Or a long term dump. Either way they are in limbo now and they couldn’t support the dividend.

    For Exelon – the question is – did this drop reflect a drop in their long term value? The answer is possibly yes – because if low natural gas prices don’t go away they can’t make an oversize profit from milking the life out of their nuclear plants which pretty much is their only inherent long term value IMHO. They do a lot of stuff that doesn’t make money and they make big profits from their generation if the average price of power stays high. It isn’t staying high and this may fundamentally be changing the value of that institution.

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  3. I was thinking about this more and the real choice, if you are going for return, is cds/bond ladder at 1% or below, or picking a decent company with a good dividend and hoping it won’t tank. So in the case of MCD you get 3.5% as of today and hope it doesn’t tank, or take your lumps with 1% or less guaranteed. To me, that is the choice. And even if a MCD does tank, you hang on to it for long enough like a CD or bond and it will almost always return, barring some insane event like a BP oil spill (and even that stock has recovered).

    Of course taxes come into play too. All of this looks different if they move dividends to ordinary income, but I think a lot of CD’s yields are already ordinary income, but I am no expert in those so correct me if I am wrong.

    With the two year treasury at .25% as of right now, this to me seems like a no brainer, I will take the huge well run company like MCD and the 3.5% every time.

    There are some corporate paper opportunities right now too, but that is definitely a different conversation.

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