It’s that time of year when dividends once again come into play.
Companies typically pay a dividend twice a year with the details of the dividend amount and timing contained in the annual and half-yearly reports. Most companies’ end of financial year is June 30, so by the time they get their books in order they then announce the final dividend for the year. At the moment it’s a trickle, but from late August through September the flood gates open and many companies announce when their dividends will be paid.
Dividends have a strong benefit for both investors and traders in the markets. With lower growth expected from shares, investors will need to get all they can from dividends. This could possibly make up a significant portion of your overall return as can be seen in this chart. The red line includes dividends, the blue line doesn’t.
Dividends Make All the Difference
Tax Benefits
Dividends also have strong tax benefits due to the franking credits that can be attached to the dividends.
A franking credit is a credit for tax that has already been paid by the company on its profits, and you as an investor gain the benefit of this. While the 45-day rule does apply to franking credits received, it is widely misunderstood. Shares must be held “at risk” for 45 days to receive the benefit of the franking credits, but this only applies if your franking credits are more than $5,000. It does not apply if your franking credits are less than this.
And for those investors receiving dividends in their complying Self Managed Super Funds, franking credits actually reduce your tax! You get the credit for the company tax rate of 30%, but only have to pay tax at the rate of 15%. The company paid too much tax on your behalf and you may even get a tax refund!
Dates and Dividends
It can get very confusing when it comes to dividend time, as there are a wide variety of different dates associated with the dividend payment. There is the cum dividend date, the ex dividend date, the record date and the payment date. All are relevant in their own right.
Cum Dividend
– This means the share is trading with the dividend attached and the buyers receive the benefit of the dividend.
Ex Dividend
– If the share is purchased on the ex dividend date the buyer does not receive the dividend. The share must be purchased before the ex dividend date to gain access to the dividend.
Record Date
– This is the day that the investors must be recorded as shareholders. Because the purchase of a share is not settled until T+3, 3 days after the share is traded the record date is 3 days after the ex dividend date.
Payment Date
– This is the day the cheques are posted to the shareholders. This could be significantly later than the record date. It is not necessary to own the share on the payment date, but it is necessary to own it on the record date.
The most important date for most people is the ex dividend date, as you must buy the share prior to this date to receive the dividend. On the ex dividend date the share drops in value, usually by the amount of the dividend.
Dividend Reinvestment Plan (DRP)
If you do not need the cash that is provided by your dividends then it is a good idea to consider reinvesting your dividends. Many companies offer the opportunity for shareholders to reinvest their dividends as shares rather than receive the dividend in cash. Some companies even offer a discount to the current price if you choose to reinvest your dividends. Discounts can be up to 7.5% of the price of the share which is a significant discount, though most DRPs tend to be at a smaller 2.5% discount or no discount at all. This allows an investor to not only benefit from the power of compounding in the price of the share it also allows an investor to benefit from compounding the number of shares as well.
If you receive all the dividends in cash the number of shares you own does not change, but as the dividend increases over time the amount of cash you receive also increases. Under the DRP strategy the number of shares you have will increase each year and because you have more shares and the dividends are also increasing, this growth compounds. Over time this can be significant.
Dividends for Traders
At one of the seminars I ran, one of the participants got really excited about the idea of trading for dividends. If a company is paying a dividend yield of 6 per cent they will usually make two payments of approximately 3 per cent per dividend. That is not a huge return on the face of it but what if you could employ leverage up to 20 times using Contracts for Difference (CFDs)? The return now jumps to 60 per cent on the margin money used.
That sounds much more attractive as a return. This theory has one major flaw: you will receive a 60 per cent return in cash on the day the dividend is paid but on average the share drops by the amount of the dividend on the ex-dividend date, losing 60 per cent of the margin requirement for a net return of 0 per cent.
But wait, all is not lost yet. There is an opportunity around dividend time, known as a dividend play. Take a look at this chart of National Australia Bank (NAB). The dividend drop can be seen in the middle of the chart. The pattern around this dividend is typical of a share’s behaviour, climbing before the dividend, dropping the amount of the dividend on the ex-dividend day and then recovering after the dividend is paid.
Share prices generally drop the amount of the dividend on the ex-dividend day
By using a series of filters on the ASX market to select a list of large companies that are actively traded and pay a good dividend, I was able to create the chart of the behaviour around dividend time.
Market trends around dividend time
This chart shows a climb of close to 100 per cent of the dividend amount from 12 days before the ex-dividend date. The peak in the share price occurs two days before the ex-dividend date. On the ex-dividend date the shares drop by 80 per cent of the dividend amount at open, fall lower during the day to 140 per cent of the dividend amount and then recover to close down about 85 per cent of the dividend amount. Over the next five days, the share recovers another 40 per cent of the dividend amount.
The obvious strategy is to buy before the ex-dividend date and sell either the day before or on the date to take advantage of the run-up before the dividend payment. An alternative is to buy the share before the ex-dividend date and hold for the recovery after the ex-dividend date, selling five days later. Although this second strategy will provide stronger returns, holding the position through the ex-dividend date will dramatically increase the volatility in your portfolio. Not all shares recover immediately after the dividend drop, even though they do on average.
Alternatively, you could buy on the ex-dividend date and sell a few days later to pick up the recovery after the drop.
Note these figures are averages and will not be seen in all cases. Stop losses are still an essential part of any strategy.
The strategy works better in a bullish market environment than in a bearish one because the dividend effect is not strong enough to overcome rapidly falling share prices. There are definitely opportunities around dividend time for traders as well as investors.
Conclusion
Dividends offer a wide variety of opportunities to both investors and traders and can be used to enhance your returns. Dividends are fairly predictable as the timing and amount of the dividend is usually known before the ex dividend date comes around. Trader Dealer publishes dividends for the week in the newsletter and posts upcoming dividends on the blog.
