Win Some, Lose Some

My Cousin Vinny is one of my favorite movies. Dale Launer's 1991 screenplay is brought to life by great performances from Joe Pesci, Marisa Tomei and Fred Gwynne. Tomei won the Academy Award for Best Supporting Actress for her role. There is some wonderful dialog in the movie, including two passages at different times containing the title of this post. The first takes place between the title character Vinny Gambini (Pesci), who is pretending to be an experienced trial lawyer, and Judge Chamberlain Haller (Gwynn):

Judge: How long have you been practicing?
Vinny: Ooh, about six, uh... almost sixteen years.
Judge: Any murder cases?
Vinny: Quite a few. Yes.
Judge: What was the outcome?
Vinny: Um, you know. Win some, lose some.
Judge: This is not the forum to be cavalier.

The second is the Judge's response to a fax stating the "very impressive legal stature of Jerry Callo", who Vinny pretended to be:

Judge: Mr Gambini. I have a fax here from the clerk of New York. I owe you an apology, sir. I'm honored to shake your hand. "Win some, lose some." Your courtroom manner may be rather unconventional, but I gotta tell you,... you're one hellavu trial lawyer. 

So, why this reference to a 1992 movie in a blog about dividend growth investing?

Well, clearly, my investments in Seadrill Ltd (NYSE:SDRL) here and here have been duds. They're in the "lose some" category. When I bought my first batch of 72 shares, I wrote that SDLR was one of my riskier buys, given the relatively short dividend history and erratic earnings. And when I added 100 shares in the first week of October, I said SDRL continues to be a risky investment for me.

Dividend Suspended

On Wednesday, 26 November, SDRL announced third quarter results that missed analyst estimates by a large margin. Instead of earning 67¢ per share, SDRL earned only 31¢ per share. Operating profit decreased to $461 million from $476 million last quarter. The significant fall in earnings mainly is due to increased tax expenses and financial losses. 

Along with the earnings announcement, SDRL suspended its dividend distributions and plans to direct those funds toward debt reduction. The company's debt is significant, especially in view of crude oil falling to four year lows. 

Following SDRL's announcements, the stock price plunged 23% on Wednesday and is trading below book value now. 

OPEC's Impact

Adding insult to injury, on Thursday OPEC decided to maintain production levels for the time-being, choosing not to fight the drop in crude oil prices from a high of $115 in June. The move is seen as taking short term pain for longer term gain by putting pressure on rival shale oil producers in the United States.

On Friday, crude oil prices dropped to below $72 and the slide has continued into the weekend, with Brent crude oil at $70.15 as I write this post. Shares of major oil companies traded down on Friday. My Energy sector holdings are down between 4% and 11%, including SDRL, which dropped another 8% following Wednesday's 23% plunge:

Company	(Ticker)	Price	Change
Energy Transfer Partners LP	(NYSE:ETP)	$  65.17	-4.13%
Exxon Mobil Corporation	(NYSE:XOM)	$  90.54	-4.17%
Chevron Corporation	(NYSE:CVX)	$108.87	-5.42%
ConocoPhillips	(NYSE:COP)	$  66.07	-6.72%
Vanguard Natural Resources, LLC	(NASDAQ:VNR)	$  23.22	-6.86%
Seadrill Ltd	(SDRL)	$  14.66	-8.32%
Helmerich & Payne, Inc	(NYSE:HP)	$  69.55	-10.52%

Risk/Reward

I've been investing in the stock market since December 2002. In those 12 years, I've experienced some big losses. Because I firmly believe in diversification, none of these losses have been devastating. In the big scheme of things, they are hick-ups. Sure, if I had followed prudent advice, I might not have experienced these losses. If I had been more risk averse, I might have avoided some or most of these losses.

On the other hand, I've had some amazing wins by not being too risk averse, including these doublers over the last three years:

• Vipshop Holdings Ltd (NYSE:VIPS): +105%
• Amazon.com, Inc (NASDAQ:AMZN): +107% 
• Novo Nordisk (NYSE:NVO): +107%
• Methode Electronics Inc (NYSE:MEI): +110%
• Ubiquity Networks Inc (NASDAQ:UBNT): +129% 
• Tesla Motors Inc (NASDAQ:TSLA): +143%
• Actavis (NYSE:ACT): +150%
• Baidu Inc (NASDAQ:BIDU): +172% 
• Priceline Group Inc (NASDAQ:PCLN): +181%
• Acme Packet, Inc (NASDAQ:PKT): +188%

These and other wins have more than compensated for the losses I've experienced. (Notice that these are not DivGro-related investments, but investments in a separate growth and value portfolio).

For DivGro, my strategy is to invest in dividend growth stocks with a proven track record of increasing dividends for at least five years running. I use several other selection criteria, but some of my purchases have been more risky than others. SDRL certainly falls into that category and I said as much when I originally bought shares. The fact that SDRL failed to live up to my expectations will not change my strategy, nor my nature. I'll continue to take on some risk with a limited number of my DivGro holdings for the chance of being rewarded handsomely. Win some, lose some...

What Now?

SDRL has disappointed me by suspending its dividend distributions. I was prepared for a dividend cut of up to 50%, which would have secured a "good enough" yield of about 7%. Now I need to consider my options:

• Do Nothing: The stock is oversold and could recover from the sharp drop it experienced. To recover completely, though, the drilling business environment would need to improve. I think it will take several years for SDRL to return to its previous highs. Furthermore, I think it will be a while before SDRL starts paying dividends again. The company could be in much better shape next year, though. By suspending its dividend, the company could just about eliminate the need for additional debt. And, given its contractual backlog, SDRL stands a good chance of surviving the offshore drilling downturn with minimal declines to its earnings base. Eventually, SDRL will restore its dividend.

• Sell All Shares: The share price of SDRL could continue to drop, especially if the price of crude oil continues to trend down. The main reason behind the dividend suspension is that SDRL is running out of cash. With the uncertain market outlook, SDRL is not assured that it would generate enough operating income to cover its high levels of debt. And if the company cannot find customers for its drilling units come off contract over the next two years, SDRL will be left with a huge interest bill and shrinking income. Finally, the company is not giving guidance on when the dividend might be resumed. DivGro is a dividend growth investment portfolio, so I shouldn't tolerate having non-dividend paying holdings. 

• Buy More Shares: Currently, SDRL is attractively valued. Shares are now trading below book value and below 5x next years expected EPS. SDRL's third quarter results were solid and the sell-off was probably mostly due to the dividend suspension. Third quarter EBITDA came in at $842 million, $179 million higher than the third quarter of 2013. Since 2011, EBITDA has generally trended up and certainly doesn't justify the market's knee-jerk reaction. The board of directors has authorized a share buyback program of up to 10% of outstanding shares. When the current drilling business environment improves and SDRL resumes it dividend payments, fewer outstanding shares will mean that paying dividends would be more affordable. Buying more shares now at depressed levels could result in outsized rewards when dividend payments are resumed. 

I'm not yet sure what I'll do. I'm leaning towards selling all my shares and accepting the loss. I sold three of DivGro's holdings this year for capital gains totaling $697.81. Selling SDRL before year-end would offset those capital gains, which would be a small tax benefit. 

Since I own 172 shares of SDRL, the dividend suspension removes $688 from my projected annual dividend income, which now amounts to $4,771. This drops me back below my goal of $4,800 for 2014. Unless there is another catastrophic dividend cut or suspension lurking, I should be able to regain the $4,800 level with my next purchase. 

What do you think should I do? Get rid of SDRL and offset prior capital gains? Keep my shares and wait for the dividend to be resumed? Risk buying more shares for outsized rewards when the dividend is resumed ?