I mean really brutal...
I know you don't want to... but I want you to take an axe to your dividend stock portfolio and ruthlessly cut out any stocks that haven't passed the simple "income stress" test I will teach you today.
Very simply, I want you to go through each of the dividend stocks you currently own and SELL the ones that chose not to continue to steadily raise their dividend payments during two important "crunch" moments for income stocks. These moments were:
1) The 2008 stock market panic.
2) The kerfuffle over dividend tax hikes at the end of 2012.
Let's take a look at why these two "crunch" moments are so revealing about your dividend-paying stocks. Then I'll explain why it's so important to invest only in consistent dividend raisers.
In the panic of 2008 credit markets froze, major Wall Street institutions Leman Brothers and Bear Sterns went to the wall, and the U.S. economy started to lose hundreds of thousands of jobs every month.
Even the safest companies were holding on to their cash for dear life. Paying out dividends was suddenly a luxury many management boards felt they couldn't afford.
Many companies that traditionally paid a decent dividend buckled. The Dow Chemical Company (DOW), Pfizer Inc. (PFE) and Citigroup Inc. (C) went down this route. Only true dividend stalwarts – companies such as The Procter & Gamble Company (PG), The Coca-Cola Company (KO) and 3M Co. (MMM) – stuck to their guns and kept steadily raising dividends.
A similar scenario unfolded at the end of last year.
Congress was threatening to raise taxes on dividends as part of the so-called "fiscal cliff" negotiations. Boards of dividend-paying companies had three choices:
1) Cut their payments so their shareholders won't be exposed to higher tax rates.
2) Issue a special dividend by the end of the year to front run potential tax hikes.
3) Keep growing their dividend payments.
Again, many dividend payers – such as Deutsche Telekom AG (DTE:FRA), Avon Products Inc. (AVP) and Watsco Inc. (WSO) – buckled. But the true stalwarts – companies such as AT&T Inc. (T), Automatic Data Processing (ADP) and Emerson Electric Co. (EMR) – kept growing their dividend payments.
For income investors, it's crucial you stick with shares of companies that kept their heads... and kept growing their dividend payments.
That's because companies that cut their dividend payments have a poor track record in the years following a cut.
Just look at the following chart. It compares the growth over 30 years of $1,000 invested in S&P 500 stocks that grew their dividends in the last 12 months (dark blue) versus those that have cut or eliminated their dividends in the last 12 months (light blue).
Data Source: Ned Davis Research / Chart Source: RidgeWorth Investments
As you can see, the difference is huge...
Special dividends can sometimes be nice little gifts. But they aren't always best for shareholders. If a company throws too much of its cash on hand at shareholders, it won't have any left to invest if the right opportunity presents itself.
This can hurt growth, as it makes product development difficult and potential acquisitions tougher. And that will weigh heavily on earnings... and therefore dividends... down the road.
But companies that raise their dividend payments... especially in periods of extreme market stress... prove that they have the financial preparedness and stable cash flows to continue to pay out larger dividends in the future.
So take a good look at each of the dividend payers in your portfolio. If they powered through these income "crunches" and kept sending you regular checks, they are probably keepers.
If they buckled... and cut their payments or reverted to a special dividend payment instead of staying the course... it's time to take out your axe.
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