Sunday, January 16, 2011

Should you ever sell a dividend machine?

Deciding if you should sell a dividend machine is an interesting question; a question I faced this last week.  Today, I want to compare two dividend machines in the same industry and use them as an exercise in how to determine if you should sell a dividend machine based on bad news.

After all, every investor tends to look at not just dividend income but also stock price. Personally I think the ordinary investor looks at the price of a stock too much and at the income not enough. Every stock occasionally has negative news and dividend machines are no exception. Since many dividend machines are in the health care field and events that can affect a stock's price occur quite often in this field, I have had clients get anxious about their dividend machines with negative news or a negative analyst rating.

Let us examine two big pharmaceutical stocks; one is Pfizer symbol PFE and the other is Johnson and Johnson symbol JNJ. Ten years ago, I had both of these stocks in my dividend machines list. Today only JNJ is on the list, PFE is gone.

You have heard about some problems JNJ has had with Tylenol and some manufacturing issues. Recently I recommended JNJ because of a drug they are developing to replace Warfarin a blood thinner. More recently, another drug JNJ is developing had negative news. However, JNJ has been able to absorb these problems and continue to increase earnings, and your dividend. Therefore, we stick with JNJ.

From 1900 to 1950, Pfizer was a premier drug company. Why did PFE cut their dividend in half in June 2009? Around 2002 Pfizer started buying one company after another to try to find a drug pipeline that would provide growth and income. They continued to raise the dividend in spite of the fact their stock price gradually slid downward. As their stock price decreased and the dividend increased, the yield was unbelievable. Pfizer had to conserve cash because the integration of the companies they bought was difficult. They had to conserve cash and cut the dividend. Once that happens, you have to sell the stock even if you take a loss. That big fat dividend was not worth it. You can have your pick of half a dozen health care stocks. Do not be lured into a stock with a yield higher than every other stock in the industry.

Move your money to another dividend machine and do not look back. Pfizer has been dead money for several years now. Until they demonstrate an ability to grow and increase the dividend every year for at least 5 years do not waste any time on this company.

JNJ continues to perform adequately for a dividend machine so we stick with it. Nevertheless, if it ever has to cut the dividend, it is out of here.

Tomorrow, a new dividend machine.

Very truly yours,