Some traders target large, established blue chip stocks like the big banks for their dividends – but rather than buying and holding them for the long haul, they trade in and out in order to generate a recurring income stream. The strategy is known as the dividend yield play and it has been fairly profitable for many traders in recent times. The question is, can it continue to reap rewards in these jittery sharemarket conditions?
As opposed to buying shares for dividend yield and potential capital growth, dividend yield play involves buying shares in a company for the sheer purpose of collecting the dividend. The stocks chosen by dividend yield players will pay fully franked dividends, however in order to receive franking credits, a stock must be held for at least 45 days before the stock goes ex-dividend, excluding the day of purchase or sale.
In short, the way it works is that once the stock goes ex-dividend, the shares are sold and the capital is moved across to buy another dividend-paying stock and the strategy is repeated.
The underlying mechanics of the strategy is as follows: typically an investor will buy the stock one or two weeks, or even a month, before the ex-dividend date. The aim is to secure the lowest price as possible, so investors tend to buy earlier (a month) rather than later (a week) as shares tend to move higher as the ex-dividend day approaches. When a company goes ex-dividend the share price often drops by the dividend amount.
Basically the investor holds the stock for 6 and a half weeks before the ex-dividend date, and aims to sell the shares at a good price once this period of time has lapsed. It often happens that stocks tend to recover after a stock goes ex-dividend.
Clearly, the aim of such a strategy is to take possession of the fully-franked dividend and hopefully make a capital gain on any share price appreciation. Many successful traders have made yields of well over 10 per cent by carefully administering this strategy in healthy sharemarket conditions. But what about now?
Although it’s true that the purpose of this strategy is to collect the fully franked dividend, you can easily come unstuck if share prices drop between buying and selling the shares. Investors don't want to be nursing capital losses on this strategy on top of the transaction costs of buying and selling.
This strategy is often aided with funds from a margin loan or instalment warrants. By using borrowed funds, investors can boost dividend yield and potential profits while claiming the interest on the loan as a tax deduction. The downside of leverage is that any small negative move in the share price will lead to a higher percentage loss and the more highly geared the investment the higher the funding costs and potential for loss.
Any strategy that involves systematic buying and selling of shares is risky because many stars need to align for a successful result. Market shocks, corrections, unexplained rallies and sell offs are the worst sharemarket conditions for strategies such as these.
The sharemarket has been nervous and jumpy over the past year, and conditions seem to be getting worse, not better. European and US bourses are selling off aggressively over the smallest whiff of bad news or worrying economic data, and Australian markets are blindly following suite. It’s almost impossible to predict the direction of the sharemarket in this climate as fundamentals take a back seat to swings based on sheer emotion.
The S&P/ASX 200 Financials index, of which banks are a part, is down 12.4% over the past year and 8.2% over the past 3 months. Shares in the major banks have been sinking all year such as Commonwealth Bank (-4.4% over 3 months, and -10% for the year), ANZ (-7.4% for 3 months and -15.9% for the year) and Westpac (-7.9% of over the 3 months and -12.3% for the year). What’s more, the banking sector has exhibited higher volatility than the overall market.
If you’d implemented this strategy over the major banks, it’s likely that you would be out of pocket due to depressed share prices, regardless of the yield received on the dividends. A more profitable strategy would have been to conduct this strategy over popular mining stocks like BHP or Newcrest Mining whose share prices have fared better courtesy of the mining boom.
The moral of the story is to be wary of short-term trading style strategies that require share price appreciation over a short period of time and the dividend yield play is certainly one of the more popular strategies that is best to be put in the top drawer until we reach calmer waters.
