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The “%” column is the percentage decrease between the “Sell Price” and “Recent Price”.  As you can see, each of the stocks continued to fall after it was sold. That adds substantive evidence that my sell after a dividend cut rule is the correct thing to do. With that said, I have begun to question if there were other indicators that should have led me to an earlier sale. Four of the above stocks have one other thing in common – they froze their dividend before cutting it. The table below shows those stocks and the price on the dividend freeze date (declaration date), along with the three stocks I currently hold with a frozen dividend:

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The “Freeze Price” is the closing price the first trading day after the dividend freeze was announced. The “Sell Price” for the first four (those that I have already sold), is the actual price I sold it for and for the three I still hold it is a recent price. Based on the above, it appears the prudent thing to do would be to sell a stock after it freezes its dividend. Like a dividend cut, an investment with a froze dividend is no longer aligned with my dividend portfolio’s goal of building an ever-increasing source of dividend income.

Care should be taken in considering that not only have the above stocks fell over the last year or so, but virtually every other stock has fell. So what appears to be hard and fast rules in this market, will need to be evaluated under different phases of the cycle. But for now, selling after a dividend cut or a dividend freeze appears to be a prudent rule to follow. However, I do not see the dividend freeze rule as stringent as the dividend cut rule. Each situation needs to be evaluated and sometimes an immediate sale is not warranted. Considering all this, I would phrase my dividend rule as such:

When an individual stock held as a dividend investment freezes its dividend, this is a strong sell indicator. The specific facts and circumstances should be immediately evaluated and continuously monitored until the stock is either sold or it increases its dividend.

If it is decided not to sell the stock, the pressure to sell should increase as time passes.  Another strong indicator to sell would be if the dividend freeze persists long enough to incur a flat dividend year-over-year. Dividend freezes need to be monitored closely. In many instances they are the first step to a dividend cut.

Full Disclosure: Long HD, MTB, RY

In determining when to sell a dividend stock, I have one hard and fast rule: When an individual stock held as a dividend investment lowers its dividend, immediately sell it. This may seem like a stringent rule and I have taken a lot of criticism for it from both directions.

Some have said waiting until a stock drops its dividend is too late. There were rumors and innuendos that Bank of America (BAC) was going to drop their dividend some time before it was announced. As it turns out, the rumors were correct this time. However, I can’t (and won’t) base investment decisions on innuendo or rumor.

Others have said that selling a stock after it cuts its dividend is too early. Their argument is the bad news has already been priced into the stock and you are selling into weakness. I feel strongly that an immediate sell is the correct thing to do for the following reasons:

I. Cockroach Theory
When a company that has a long history of raising dividends and suddenly stops, it is usually more than a simple bump in the road. For the one cockroach you have seen (lower dividend) there are probably hundreds waiting to reveal themselves.

II. Adultery Theory
I view a dividend cut as financial infidelity by the company. After a company has raised its dividend 10, 20, 30 or more years that first dividend cut is very hard. Like someone who first has a series of affairs after 30 years of marriage, the first one is guilt ridden, but it is much easier the second time around. Eventually, the guilt goes away. Do you think Citigroup (C) would have the same difficulty cutting its dividend again? In the case of C, I sold part of my position when it became evident that their capital structure could not sustain the company going forward without a substantial cash infusion.

III Experience
My experience has been once a company cuts its dividend, the stock continues down. That has been the case with these that I sold after a dividend cut (prices as of 10/13/08):

• Washington Mutual Inc. (WM) – Sold at $18.11 on 12/11/2007, now worthless
• Wachovia Corporation (WB) – Sold at $25.89 on 4/15/2008, now $5.85
• iStar Financial Inc. (SFI) – Sold at $2.32 on 10/3/2008, now $1.46
• Bank of America Corporation (BAC) – Sold at $28.51 on 10/7/2008, now $22.79

Sure BAC will likely come back over time, but WM and WB will never come back. Even assuming BAC will come back at some point in the future, I likely would have been better to sell, wait for the 30-day wash sale window to clear and buy it back (see IV below on why this is not an option for me.)

IV Portfolio Goals
The most important reason for selling a dividend stock after it cuts its dividend is that the investment is no longer aligned with my dividend portfolio’s goal of building an ever-increasing source of dividend income. Some have argued that certain securities are good value plays after a dividend cut. This may or may not be true, but my dividend portfolio’s primary objective is dividend income, not capital gains. I have a separate portfolio for that. To date, I have not transferred any dividend stocks to my capital appreciation portfolio.

Finally, some will say that it was the “right” thing to do for the company to cut the dividend given the circumstances. In many cases I do not disagree. However, in the cases I have been involved with the company was not “given” the circumstances, they created them through their own actions. If a company was truly a victim of circumstances which couldn’t possibly be foreseen or planned for, I would gladly to cut them some slack and consider an exception to my rule. This situation rarely ever comes along.

Disclosure: No position in any of the aforementioned securities.