Reducing risk was our chief priority this month, and we sold six underperforming positions between July 1 and July 27. We’re not predicting anything, but tightening up your portfolio when risk is elevated will better prepare you for whatever the market has in store—good or bad.
Although I choose every Cabot Dividend Investor position with the intention of holding and collecting the dividend for years, if not decades, our sell rules demand we sell under a number of conditions, which can be roughly dividend into two broad categories: fundamental weakness or unacceptable risk. Sometimes both play into the decision to sell a given holding, as with our sale of DuPont (DD) earlier this month.
Fundamental Weakness
Cabot Dividend Investor investments are chosen after careful consideration of a number of important metrics that affect the company’s ability to pay its dividend, longevity and growth potential. If a company’s fundamentals start to slip in any area, the stock is at risk of no longer earning its place in our portfolio.
Fundamental reasons for selling can include (but are not limited to):
• Declining IRIS ratings
• Dividend Cuts
• Payout Ratio Rising to Dangerous Levels
• Debt Increasing to Unhealthy Levels
• Deceleration in Revenue, EPS or Free Cash Flow Growth
Unacceptable Risk
While numbers never lie, they’re sometimes slow to catch up to reality. That’s why we may also sell holdings whose fundamentals are still solid, as with our sale of PPG Industries (PPG) on Monday. In cases like these, the long-term picture is still bright, but the short-term risk has become too great to continue to hold. (When we talk about risk, we mean risk of losing money.) Factors that can trigger selling in these types of cases include:
• Macroeconomic or industry factors are working against the stock and likely to persist. This played into our sale of Chemours (CC) earlier this month.
• Lack of technical support: A lack of buying power was the main reason we sold Omnicom (OMC) earlier this month and PPG Industries (PPG) on Monday. Trends are powerful, and being on the wrong side of them can get expensive.
• Mounting Losses: While we aim to invest long-term and will ride out some corrections, losing a chunk of your capital up-front is harder to recover from than you think, and not always worth tolerating for the promise of long-term returns. Once your initial investment is depleted, your remaining capital has to work even harder to make up the difference.
Taking Profits
Lastly, we also have provisions for taking profits to reduce risk, as we did with ConEd (ED) back in February. ED is still an attractive long-term holding, but with the price having run a large distance in a short time and beginning to come back to earth, risk was elevated. We reduced risk without exiting the position by taking profits on a third of our holdings.
As with everything else, feel free to email me at any time with questions about our sell discipline.