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Wednesday, November 19, 2014

What Should I Do About Those Non-Dividend Paying Stocks I Received In A Spin-Off?

 
In a previous article, I discussed the idea of dividend investors holding non-dividend paying stocks. After I wrote the article a few weeks ago, I realized that I have received/am about to receive shares in two companies following two separate spin-offs.

I receive one share in CDK Global (NASDAQ:CDK) share for every 3 shares of Automatic Data Processing (NASDAQ:ADP). Based on reading the dividend policy of this company, it is unclear whether they will be paying a dividend in the foreseeable future. Based on expected earnings of $1.37-$1.39/share, the stock is selling for 26.30-26.70 times forward earnings, which is pricey. If we get high single-digit earnings growth over the next decade,however, it could be worth holding on to this business.

I receive one share of Halyard Health (NYSE:HYH) for every 8 shares of Kimberly-Clark (NYSE:KMB). The company has stated that no dividends are expected to be paid. The company earned $154.6 million in 2013, and has approximately 46.5 million shares outstanding, which equates to approximately to an EPS of $3.30/share. Thus, the company is selling for approximately 11.50 times earnings, which is pretty cheap. While revenues have been stagnant for the past 3 years, net income has grown slightly. If they manage to streamline operations, repurchase stock or start growing income organically, shareholders could do pretty well by holding on. If they initiate a dividend and start growing it, I would have less reasons to not hold on to the company.
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So I am trying to decide what to do. I basically have two options:

1) Sell

This sounds like a logical option for someone who calls themselves a dividend growth investor. If my goal is to earn more in dividend income from my portfolio, it would seem a waste of capital to hold shares in companies that do not pay dividends. I could essentially sell the shares, pay the capital gains taxes, and reinvest the proceeds in something that pays dividends. Since my goal is to earn more dividend income from my capital, I should not hold on to shares in companies that have mentioned that they won’t continue the legacy of regular dividend growth of their parent companies.

For some investors, having two extra companies in their portfolio would probably trigger a sale, because it would exceed a self-imposed number of companies they want to own. In addition, many index funds that held Automatic Data Processing (ADP) in their portfolios were selling shares of CDK Global (CDK) merely because CDK was not a member of the S&P 500, without questioning whether CDK is a good business to own.

2) Hold

http://www.contrarianinsights.com/I could also just sit tight and hold on to those shares. This is because stock spin-offs usually do really well, as the new company gets management whose sole focus is on managing it rather than a division whose goals and needs are lost in a larger company. In addition, I have found through an analysis of the sales I have made that selling a company and buying another one usually results in poor results. This is because I pay capital gains taxes on the gains, which leaves me with less money to reinvest. In addition, I have reinvestment risk if I sold and bought something that doesn’t perform as well. The more time I spend reviewing investments, the more I realize that the biggest risk is not that a company goes to zero, but that I miss out on a potential for large gains.

Conclusion

I believe that I will simply hold on to those shares for the time being. In addition, despite the spin-offs of shares, my total dividend income will be unchanged since Automatic Data Processing (ADP) and Kimberly-Clark (KMB) are holding their dividends per share steady. Update: Actually, ADP just increased their dividend by 2% to 49 cents/share, citing the high payout ratio as a reason for the slow increase. This dividend champion has grown dividends for 40 years in a row, and is targeting a dividend payout ratio of 55%-60%.

The position in Halyard Health (HYH) is really small, since I received 1 share for every 8 shares of Kimberly-Clark (KMB). So the amount I received is roughly equivalent to the dividend from Kimberly-Clark (KMB) for 1-1.5 years. Based on my study of historical Kimberly-Clark spin-offs, it might pay off to sit tight rather than lose capital to taxes and reinvestment risk.

There was a spin-off from Kimberly-Clark in 2005, called Neenah Paper (NYSE:NP). The company was paying a quarterly dividend of 10 cents/share that was unchanged for about 6 years, until it started raising it to about 27 cents/share in 2014. Thus, if you held for 10 years, your dividend income would have increased by 170%, which is not bad at all. Either way, the investor in the company earned a total return of 7.50%/year since the spin-off. The investor in S&P 500 earned approximately 7.70%/year.

There was another spin-off from Kimberly-Clark in 1995, called Schweitzer-Mauduit International Inc (NYSE:SWM), which made cigarette paper and related tobacco products. That company didn’t pay a dividend for the first 6 months after the spin-off, and started at 7.50 cents/share every quarter in 1996. The dividend was held steady until 2012, after which it has been increasing to 36 cents/share every quarter. This goes to show that the most in profits is made by the patient investor, who holds on to their ownership through thick and thin and doesn’t get scared away easily. Of course, waiting for a dividend increase for 16 years is a tough proposition. Either way, the investor in the company earned a total return of 10%/year after the spin-off. The investor in S&P 500 earned approximately 8.40%/year. 

The position in CDK Global is slightly larger, but not by much. A previous spin-off from ADP called Broadridge Financial Solutions (NYSE:BR) has done pretty well, and has paid and increased dividends to shareholders since 2007. It paid a quarterly dividend of 6 cents/share in 2007, which increased to 27 cents/share by 2014. The company has done much better than an investment in S&P 500 since 2007, by providing a total return of 172% versus 67% for the stock index.
The more important thing is for those companies to be able to grow earnings per share. In addition, it is possible that they pay a dividend at some point in the future. After looking at the sales and earnings trends for the two companies over the past few years, I believe that they would be decent investments. I will wait for one or two years’ worth of performance as separate businesses, and see how promising they are as investments. At that stage, I will decide whether it is worth holding on to those companies based upon their business performance.

Source Url:http://seekingalpha.com/article/2692775-what-should-i-do-about-those-non-dividend-paying-stocks-i-received-in-a-spin-off

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