I Just Sold This Stock

Note from Daily Trade Alert: As long-time readers are aware, Dave Van Knapp is a highly-respected authority in the dividend growth investing (DGI) space. He even put together a series of lessons to help guide our readers through the rewarding world of DGI. What you may not be aware of is that since 2008 Dave has maintained and made public a real-money Dividend Growth Portfolio. He created it to demonstrate the results that can be achieved by following sound dividend growth investing principles. With this in mind, we’re pleased to announce that starting today we are making Dave’s portfolio easily available to Daily Trade Alert readers.  You can access it via the Dividend Growth Investing tab at the top of every page. In addition, Dave has agreed to alert us whenever he makes a significant change to the portfolio, such as the following article…

Although dividend growth investing is mostly about accumulating and reinvesting, once in a while a reason pops up to sell a stock.

I recently sold my stake in Darden Restaurants (DRI) from my Dividend Growth Portfolio. The reason: I lost confidence in management’s ability to pull its business out of a long slump, and indeed I began to consider the next dividend increase to be in danger.

Darden is the company that owns Red Lobster®, Olive Garden®, LongHorn Steakhouse®, Bahama Breeze®, and several other restaurant chains. Most of its restaurants fit in the category known as “casual dining.” Darden is the largest player in that space, and several of its brands are among the best-known in the industry.

[ad#Google Adsense 336×280-IA]For years, Darden’s strong brands, attractive concepts, and good locations produced growing sales, and it operated at a high level of productivity.

The company’s size gave it bargaining clout over suppliers as well as advertising efficiencies that led to industry-leading operating margins.

In the past year or two, however, Darden’s outcomes have been deteriorating.

Heavy competition in the industry, including undercutting from the “fast casual” dining segment, has hampered Darden’s ability to grow.

Competition can be fierce in restaurants, as customers have no switching costs – they can go somewhere else without losing anything for making the switch.

The problems became most pronounced at Olive Garden and Red Lobster, which together produce about 75% of Darden’s revenue. The company has suffered from a series of quarterly earnings disappointments, and it has been guiding expectations lower.

In March, Darden released a strategic plan to enhance shareholder value. When I read the plan, I actually lost rather than gained confidence. While the plan has positive elements, it felt like issues were being addressed that should have been dealt with a few years ago. Topics included:

• The separation of Red Lobster, either by spin-off or outright sale. If by spin-off, then (according to the document) the resulting new company, by design, would have a sub-investment-grade credit rating. Presumably current shareholders would be issued shares in the new company.

• Reduction in unit growth across all brands. Pulling back is a tactic often employed by companies that have over-expanded or are trying to regain solid footing.

• Redesign of Olive Garden’s logo, menu, store design, and general “feeling” for customers, with rollout across the chain over the next few years.

• Cost-cutting initiatives to protect its credit rating and bring operating costs in line with peers.

Last July, DRI raised its dividend 10%. Was that prudent? Just a couple months later, S&P lowered DRI’s credit rating a notch, to BBB- (the lowest “investment grade” rating, one notch up from “speculative”). Darden has a CreditWatch status of “Developing,” meaning that the company’s rating is potentially in flux.

Normally, DRI would increase its dividend in July, with the announcement coming before that. Taking everything into account, I concluded that the next increase is in danger. I had a small profit in the stock, and I decided to cash it in.

As I have explained about my Dividend Growth Portfolio, I manage it according to what I call its Constitution. The Constitution includes guidelines for selling a stock. Specifically, these are my selling guidelines:

Investigate and seriously consider selling any stock for these reasons:
(1) It cuts, freezes, or suspends its dividend.
(2) It bubbles or becomes seriously overvalued.
(3) You receive news of significant changes impacting the company.
(4) It is going to be acquired.
(5) It announces plans to split itself or spin off a separate company.
(6) Its current yield rises above 9 percent or drops below 2.5 percent.
(7) It underperforms the market in total returns (price + dividends) for three
years running.
(8) Its size increases beyond 15 percent of the portfolio.

This sale falls under #3 and #5: There are significant changes impacting the company plus there exists the possibility of a spin-off. A short time ago, I concluded that the accumulation of bad news for Darden made it necessary to place the company on a sort of special watch. That level of scrutiny led to my decision to sell it.

I sold my shares on April 8, the ex-dividend date for the next dividend distribution, scheduled for early May. By selling on the ex-div date, I preserved my right to receive that dividend. (See Lesson 1: What Is a Dividend?) The ex-div date is important to keep in mind when you are considering buying or selling a dividend growth stock. The person who bought the shares from me will not receive the next dividend. (They will, of course, receive the one in July.)

In my portfolio, I generally stay fully invested. So with the proceeds from the sale of DRI, I quickly purchased two other stocks. One of them is Coca-Cola (KO), meaning that I increased the stake that I started earlier this year. (You can read about that purchase in “A Top Dividend Growth Stock for 2014.”)

I will tell you about the other stock that I purchased in my next article, which will be the second in my series of articles about four of the stocks in my eBook, Top 40 Dividend Growth Stocks for 2014: A Sensible Guide to Dividend Growth Investing. It is a new stock for this portfolio, keeping the total number of stocks at 17. It is a dividend growth icon, and I am glad to add it to my portfolio.

Dave VanKnapp
Author of Top 40 Dividend Growth Stocks