What do I do When my Dividend Stocks Become Over-Valued?

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final sell culminated in total profits that were almost 35 times my original investment, and proved to be a very fortuitous decision as EMC’s stock price finally reverted to the mean and collapsed.

The important lessons to be learned here are that there is no telling how irrational the market can get.  In my opinion, each and every one of my five unwindings of this position were done at what I believed were obvious and dangerous overvaluation levels.  Interestingly, in the long run I was correct in each and every case.  But the reader should understand that this was an extremely rare and unusual situation.

Furthermore, the only reason I was willing to hold on was because I was playing with house money after my initial sell.  Although I consider every one of my decisions good ones, they were all far from perfect.  Ascertaining overvaluation correctly is easier said than done to perfection, but it can, and should be done, when reason dictates.

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Fiserv, Inc. (NASDAQ:FISV)

My next example, Fiserv, is another non-dividend paying stock that I wanted to share because it tells a quintessential story where valuation works perfectly.  I originally invested in this company in November 2004 when it was fairly valued, and subsequently sold out at the end of May 2007 at a tidy profit.  I tend to be quicker to pull the trigger when there’s no dividend involved.  I then repurchase the company in April 2010 again at fair value, and again I’m currently enjoying a nice profit.  I do consider the stock only modestly overvalued, and I’m happy to continue holding it based on its impeccable long-term operating record.

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NIKE, Inc. (NYSE:NKE)

My Nike example tells two important stories about buying and selling based on overvaluation.  My original purchase was sound and my first two sells where appropriate, but not complete.  Some 14 months later, Nike was trading substantially lower than I partially sold it for.  However, I still had half of my original position, which I was now holding at a loss.

Then coming out of the recession Nike once again moved to a similar overvaluation level at which I sold my original half position.  Learning my lesson, at least I thought I did, I was happy to liquidate my remaining shares.  Approximately two years later Nike is trading at a significant premium to my final liquidating price.  Since my final outcome was a substantial profit on all shares, I really can’t complain.  However, Mr. Market has taught me that he is a very unreliable partner.  Nevertheless, I consider Nike one of my favorite companies, but I continue to believe it is significantly overvalued.

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Wal-Mart Stores, Inc. (NYSE:WMT)

My final example, Wal-Mart Stores, Inc. (NYSE:WMT), teaches another important iteration of the dangers of overvaluation.  I originally bought Wal-Mart at a fair valuation in October 1995.  Two years later I sold half my position, convinced that the stock can become overvalued.  Approximately seven months later I liquidated the holding completely as I was then absolutely convinced that the price had risen as high as it possibly could.  Of course, I was wrong as the stock advanced for approximately another 18 months before it hit a wall.

Then for approximately the next eight years Wal-Mart’s stock price, now completely disconnected from its earnings justified valuation, had nowhere to go but sideways, then down.  Consequently, even though the company generated strong and consistent earnings growth, shareholders actually experienced losses due to the headwinds of extreme overvaluation.  Wal-Mart did not fall quickly like EMC did, instead it went into a torturous decline spanning many years.

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Summary and Conclusions

There is no doubt that the recent run-up in stock prices has created overvaluation in many stocks.  On the other hand, there are still many stocks that are reasonably valued, and even some that are undervalued.  So the important point that I am suggesting is to make your valuation decisions one company at a time.

If you do hold overvalued positions, I also suggest that you remember the principles that were cited by Warren Buffett earlier in the article.  If you are buying businesses, then the ultimate strategy is to hold as long as the business remains strong, and valuations fluctuate within a reasonable range.  I only recommend liquidating a position if the risk of owning it is too great to hold any longer, or if you come across a compelling alternative that improves your overall portfolio position.

With this article I attempted to illustrate that valuation comes in many sizes, shapes and flavors, and each will dictate the appropriate behavior and actions required or necessary to deal with it.  Sometimes the best course of action is to simply hold tight.  At other times it might make sense to partially liquidate a holding if the momentum is strong.  This can be especially beneficial if you can de-risk your portfolio by taking all of your original cost or

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