This is the third and final part to the Art of the Dividend series. In this part we will look at the risks involved with the dividends strategy and what can be done to offset them. This will be followed by a recap of what was discussed in the two previous reports with further points to consider.
Risks: The chief risk in any dividend strategy is the possibility that the company might be forced to cut or eliminate its dividend. Dividends are not guaranteed by a contract in the same manner that bond interest is. Each quarter the Board of Directors meets and must agree about the amount and timing of the upcoming dividend. Most companies that offer dividends strive hard to maintain them and even grow them, as the management is fully aware that cutting dividends would likely cause the stock’s price to tank. As most CEO’s and board members are big shareholders, they have great stakes of their own to consider. The best protection against being stuck with a dividend cut is to periodically review the fundamentals. If you spot any major deterioration in revenues and/or cash flows, it could be a sign that the dividend will be cut.
There is some risk to dividend timing. This is especially true with foreign companies that do not have the exact same reporting requirements that we have in the U.S. You might be expecting to receive a dividend only to find out that it has been cancelled or postponed past the ordinary date. Further, some foreign companies will not publicize the ex-date of an upcoming dividend until after its passed. Keeping the potential ex-date on a watchlist of dividend stock candidates and updating it when the announcement is made may help to avoid sitting and waiting past your forecasted date when the capital could be put to better use.
Another potential risk comes with the stock’s price going down after the stock goes ex-dividend. There are perhaps thousands of dividend investors a number of which are trying to increase their yields in the same or similar manner discussed in this blog series. A group of them might be planning to sell large blocks of the stock as soon as it goes ex-dividend thereby driving the price down. Checking the previous ex-dates against the stock’s chart could disclose a pattern of the stock’s price routinely tanking after it goes ex. If this pattern does exist, check to see if the gain the stock is currently making is substantial and then sell it beforehand. If you have your choice between waiting for the dividend and then watching the price tank on the one hand or collecting a capital gain on the other, your best move might be to forgo the dividend and sell.
If all else fails, you can always hold the stock until the next dividend cycle. During that time a price increase will give you the option to get out with a gain before the cycle ends.
Recap: Let’s highlight the process in a series of steps.
1. Prepare a watch list by sorting through lists of candidate dividend stocks and weeding out those that don’t provide the overall return you’re looking for. Include on the watchlist the ex-date (or forecasted ex-date) so you’ll have a handle on when the stock will pay. I have from 25-30 positions at any point in time with about another 30 candidates on the watch list.
2. Periodically review the fundamentals of the watchlist candidates. If you have any long running stocks in your positions, review the fundamentals of those stocks as well to be appraised of changes in the company’s finances that could lead to a cut in the dividend.
3. Seek a good entry point when investing. There’s no hard and fast rule with this, but generally as a dividend investor you want to watch closely which stocks have a pending dividend inside of a month or so. Good entry points come from technical analysis of the stock’s current price, trends, momentum, and strength.
4. Select exit points judiciously after the stock goes ex-dividend. The capital can then be rolled over into another position on the watch list yielding a dividend sooner than waiting for the next quarter. When exiting, the stock should be returned to the watch list.
5. Strive to shorten the duration of each position to include the dividend and any gain possible while releasing the capital for another position. If a large gain is present and the stock has a tendency to tank when it’s ex-dividend, sell beforehand and take the gain off the table. You can always go back into a new position for the same stock at a future time when the ex-date approaches.
6. Pay attention to the yield of the stock in connection with your fundamental analysis. Ultra-high yields often mean that no one else wants the stock for some reason that you don’t yet know about.
7. Be aware of the risks—the most significant of which is that the dividend will be cut or eliminated. There is also substantial risk of capital loss when the stock trades ex-dividend, or if the timing of the ex-date is not publicized beforehand.
8. Be aware of changes to the economy and to market conditions. We’ve had a rising market over most of the last 12 months, and that makes almost any strategy a winner. But the only thing constant about stock markets is change itself. If a strategy seems to be bogging down, perhaps a change is needed.
9. It’s very difficult and probably unrealistic to think that you can regularly turn capital around by moving into a dividend stock the day before it trades ex-dividend, and then sell it immediately after. But, by extending the time on the buy side and keeping it as long as feasible on the sell side, you can shorten the duration of the position and increase your overall returns by rotating the capital around to other low hanging fruit.