In this analysis entry points, exit points, and durations will be discussed as we look at a dividends strategy to supplement the investor’s income. Essentially, a good dividends strategy is similar to a good growth and income strategy, except that income is in the forefront, and duration is managed differently. Growth remains important, but is co-incidental. The dividends strategy is also compared to fixed income investments.
Entry Points: Entry points are managed in almost the same way they would be in growth related strategies except that one other criterion must be considered—the stock’s ex-date. When a dividend is declared, the date the stock trades ex-dividend is also announced along with the date the dividend is paid. Dividends are usually paid within a month or so after the ex-date, but sometimes the pay date is up to 1 – 2 months afterwards. This strategy ignores the impact of the pay date, but individual strategies might want to consider incorporating the pay date into the decision-making matrix.
To be paid the dividend, the investor must own the stock before it trades ex-dividend. It can be one day before just as long as it is before. As soon as the stock trades ex-dividend, it can be sold, and the investor still will receive the dividend. Best practices to achieve a good entry point are to monitor the current price of the stocks on the watch list starting at least a month before the stock’s ex-date. The goal here is to get the best possible entry point price inside of the one month before the stock goes-ex. When searching for an entry point, technical measures should be considered such as trend, whether the stock is under accumulation or distribution, momentum, resistance level and support level. A good tool to use for that is Market Edge which furnishes updated technical information.
Exit Points: Selling a stock as soon as it trades ex-dividend releases the capital and enables the investor to repeat the entry cycle with another stock and pick up another dividend inside of a shorter waiting period for the original stock to go ex-dividend again. In other words, the investor should keep moving the capital around to pick up the dividends at a quicker pace than they would occur if the stock strategy were buy and hold.
However, what if the stock loses value after it begins trading ex-dividend? The strategy would continue to work as long as the stock has made a viable net gain including pullbacks from the entry point to the ex-date including the dividend in the calculation. If not, then the investor needs to decide if the stock still has a chance at moving up in price. If the answer to that is yes, then holding the stock through another dividend cycle could be the solution to avoid realizing capital losses in order to pick up dividends. If the stock has a major capital gain prior to the ex-date, the investor needs to decide if the stock should be sold before the ex-date thereby foregoing the dividend in favor of collecting the capital gain. If the stock has a propensity to drop in price when it trades ex-dividend, the greater value might be to cash the gain.
Duration: The holding period for the dividend strategy has two dimensions: the amount of the dividend, and any price appreciation or depreciation that has or could take place. Comparing stocks to bonds we can look at dividends in a similar way that a bond investor would look at interest. The duration of the holding period for dividends is not fixed by contract, but the yield still works the same. That is: principle, times rate, times duration equals the yield (i = prt). For bonds the interest is paid when it is determined by the contract, but the interest is earned every day. The dividend investor does not earn the dividend each day he holds the stock—he earns it only by owning the stock at least one day before it trades ex-dividend.
For a $1,000 bond (1 bond) that pays 5% interest held for 30 days, the interest would be
i = 1,000 * 0.05 * (30/360) or $4.16
For a $1,000 stock (1 share) that pays a quarterly dividend with a 5% annual dividend rate held for 30 days through the ex-date, the dividend would be
d = (1,000 * 0.05) / 4 or $12.50
The dividend investor can increase his yield by shortening the duration—something the bond investor cannot easily do. The value of both investments is subject to changing on a daily basis as markets will impact the yield, but the vast majority of stocks will move in a more volatile manner than bonds.
Most stocks will declare dividends quarterly. However, some declare monthly while others declare semi-annually or annually. Dividend strategies should be altered as necessary to accommodate dividend declarations that are other than quarterly.
The next session will take a look at risks involved with the dividend strategy.
Thanks David