DIVIDEND STRIPPING

MONDAY 19TH OCT 2009

DIVIDEND STRIPPING
A Guide to getting the most out of Dividends
Every six months the results season comes around. Every
February and every August and results time is the time to start
maximising those relatively huge Australian dividend pay outs.
On current forecasts over a third of the top 200 stocks yield
more than 6.0% including franking. So theres plenty of value
out there.
WHAT IS DIVIDEND STRIPPING
A lot of you probably know all about dividend stripping and
you will all have had a variety of success or otherwise with it.
But for those of you without the experience but with enough
nous to know you could be maximising the income and
franking on offer in the next couple of months then here are a
few pointers:
The basic principle of dividend stripping is to buy a stock before its Ex dividend date and sell it after it goes Ex
dividend. The hope is to pick up the dividend, the imputation credit and a capital gain at the same time.or at
least a capital loss which is smaller than the dividend gain (and you use the capital loss to offset gains
elsewhere).
Stocks with big dividend pay-outs often run up in price ahead of the Ex Dividend date. Traditionally the banks
will run a month ahead of their results..so buy early, not the day before.
In a low interest rate environment the attraction of dividends over interest means some reasonably predictable
share price rallies in safe income stocks ahead of results.
Remember the 45 day rule. If you are going to achieve more than the ATOs maximum level of imputation
credits in the tax year (currently $5,000) then you need to observe the 45 day rule. This says that you need to
hold a stock for 45 days not including the buy or sell date to qualify for the franking credit and you must have
the risk on the stock for the entire period (cant hedge 100%). So buying 45 days before a stock goes Ex
dividend makes sense and doing so will usually catch the pre dividend run if there is one and will give you the
freedom to sell immediately the stock goes Ex should you wish to. (You dont have to buy 45 days before it
goes Ex.you can buy 1 day before and hold for the next 45 days if you like).
The share price drops the day it goes Ex Dividend.usually by the size of the dividend. Most dividend
strippers work on the basis that when a stock goes ex a 20c fully franked dividend it usually drops 20c.not 20c
plus the franking.so they are hoping to pick up the franking for free.
In stocks that are not reliable payers but have a big one off dividend, the post dividend fall tends to be more
pronounced as the people who only bought for the dividend exit again and there are no natural buyers to
support the stock. In other words it is hard to strip big dividends out of stocks that dont regularly pay big
dividendsbecause they are not defensive and you get caught in the sell at all costs, the games over selling
after the dividend goes Ex. Rubbish companies paying big dividends are to be avoided because there is no buyer
for dividends strippers.
A capital loss. When the stock goes ex dividends and drops 20c you collect the dividend but lose 20c of
capital.which is a tax saving as well (perverse theory). Dividend stripping is often a swap between income
and capital gain. Better if you have a lot of capital gains to offset.
Overseas shareholders dont get franking credits.so stocks like Qantas with large foreign shareholder
bases are often thought to be sold off by international traders ahead of a big dividend and then bought back. This
is not a factor in small stocks that are not institutionally held.
The stocks that are most likely to carry their dividends (go up after going ex dividend) are the big
internationally traded stocks.because international funds who dont get the franking may sell before the ex
date and buy back afterwards. Or they may prefer to delay their buying until after the ex dividend date rather
than buy before and end up paying a premium built into the share price ahead of an ex date by the domestic
investors who are buying for the franking. In other words you are safer buying banks and big income stocks that
international institutions will support after they go Ex than you are crappy little stocks that no one wants to buy
after they go Ex.
Dividend stripping is a lot more profitable in a rising market. In a bear market you are on a hiding to
nothing. The current market volatility does not make dividend stripping easyit is no lay down. In which case
the best ploy is to try and strip stocks you wouldnt be too concerned holding on to in the medium term should
the market go against you.
When stocks like the banks go Ex Dividend.there is often quite a switch out of the bank that went Ex and into
the next one going Ex. So if you have the cash you would be buying Bank X before Bank Y goes Ex in
anticipation of all the Bank Y dividend strippers buying Bank X when Bank Y goes Ex (lost you there I expect).
Imputation credits are now the equivalent of cash because you can claim them from the ATO. It used to be
you could only offset them against income tax..so non tax paying funds (super funds) had no use for them.
This is not now the case. Franking credits are of use to pretty much everybody whether they pay tax or not.
Super funds should now be collecting franked dividends because franking credits are cash.you can claim them
back as cash.you do not need to be paying tax to make use of them. So super funds should work the dividend
season hard, especially those funds that are already paying out to members and are focused on income.
It is a wonder that brokers continue to quote yields without including the franking amount.maybe because
they are writing research for international fund managers (who dont get franking) as well as us. But the gross
yield is the yield for all intents and purposes if you are an Australian Mum, Dad, Super Fund or pension.
Some companies go Ex Dividend very soon after results (usually the bigger stocks like the Banks). Others go
Ex Dividend months after results. You need to be aware of this when stripping. The Banks for instance usually
go Ex the Monday after the week of their results. Some companies go Ex weeks after results.
The Ex date is not the pay date. There is a set pay date for each dividendthe date the cheques are sent
out..well after the Ex date usually.
Retain your dividend statement from the company.it has your imputation entitlement on it. You will need it
to claim the credit back from the tax man when you put your tax return in.
There are other issues with partially franked dividends too complex to explainthe catch all is to make sure
the company has your TFN every time by putting your TFN on every transaction through CHESS and you will
ease the complication.
DEALING COSTS
Some brokers suggest dividend stripping is a little like negative gearing.nice concept but pointless unless the
underlying asset price rises as well.
Dealing costs are the biggest concern when dividend stripping. In fact dealing costs can make the whole process
pointless and often you would not strip dividends if you did the numbers. It is no good buying and selling a
stock for a 2% dividend yield and paying 1% commission on the buy and 1% on the sell.
Dividend stripping dealing costs can make it not worth the risk. In a rising market fine.but in a flat or falling
market the costs will often negate the gains. So when dividend stripping you need to minimise your dealing
costs.somehow.
Some brokers also suggest that by the time you have sold CBA to buy ANZ sold ANZ and bought back CBA
you have in fact switched four times instead of twice and your dealing costs are 4%....not 2%. In which case that
will dwarf most dividends you pick up.
What all this means is this....dividend stripping will only really pay off when the stock you buy goes up in price
as well. Luckily, in a low interest rate environment and in a rising market, big income stocks are prone to
perform well over the dividend period because people do chase the dividends.
When you consider the costs it becomes pretty clear that in order to make good on dividend stripping you really
need to be buying good stocks, in a rising marketthat just happen to be going Ex dividend.
WATCH OUT
Some stocks have big yields because they are dogs. If the share price has fallen a lot and brokers havent
changed their dividend expectations then some stocks appear to have enormous yields. So when a stock comes
to your attention because of the size of its yield alone, have a look at the share price chart. If this shows a
tumbling share price, or profit warning collapses, then watch out. Dont buy before the results because they may
well cut the dividend pay-out despite what the consensus forecasts appear to say.
Even if one of these struggling companies maintains its dividend after results and really does have an enormous
yield, watch out again. Stocks like this are unlikely to be trending up.(so you may lose money during the
holding period)..and when they go Ex dividend they can drop hard and drop again as the people who bought it
for the dividend or held on for the dividend (and not the fundamentals) dump it after it goes Ex.
All in all, if the stock has been a terrible performer and that is why the yield is so high you had best just leave it
alone. No good buying a rubbish stock for any reason.
There is a rule of thumb in the stockmarket - If a stock yields close to 10% before franking the likelihood is, it
doesnt.
THE PERFECT DIVIDEND STRIP You buy a bank share 46 days before the Ex Date. The stock has
results. They are good and the share price rises. The stock goes Ex Dividend. The share price carries the
dividend and closes up that day. You sell with a capital gain, entitlement to the imputation credit and you get a
cheque for the dividend plus franking. Your broker rings you to say how much he loves you for churning your
stocks around.
THE NIGHTMARE DIVIDEND STRIP You read a bit of research about a small retailer that has a
consensus forecast yield of 10.5% and it is fully franked. Results are coming up so you decide to buy early to
get a head start on the 45 day rule. The stock falls ahead of results. The results are terrible and the dividend is
cut. But it is still a big dividend yield so you hold on for the Ex date. The stock slides into the ex dividend
date. Once it goes Ex 10c the share price opens up down 14c (the dividend plus the franking) and sellers beat
you to it and it falls 20c. It then continues to trend down in a very illiquid market. You start asking questions.
Seems you failed to notice the 15% fall in the share price after a profits warning a month before you bought in.
The reason the stock had a 10.5% yield is because the share price had fallen and the yield was based on a pre-
profit warning dividend forecast. Your mistake feeling the width without a concern about the quality. You sell
it then of course it bounces.
Moral only buy stocks for the dividend that you would be quite happy to hold a bit longer if the strategy went
oblong in the short term.
THE UNCANNY SCOTSMAN
One of my institutional clients
used to be a Scottish income
fund. When I was initially
talking to the fund manager about the income requirements of
the fund he simply said Feel the Width. In other words he was
interested in one thing, big dividends. Stripping dividends
wasnt his game he said, apparently he was in the business of
investing in quality high income stocks. But the truth was this, he
worked the dividend season like a dervish, trying to successfully strip
dividends without losing capital. That was his job. But he had
a couple of rules
Buy early - As an income fund he had to buy before the whole market started chasing quality stocks ahead of
results and dividends. It was his bread and butter to make money out of the rest of the market getting excited
about results and dividends.
Never sacrifice capital for income One of his famous explanations was lend me a pound and Ill pay you a
10% yield pa for ten years. Sound attractive? At the end of ten years Ill send you a letter saying that
unfortunately the fund is now worthless thanks for the lend of your money. In other words income alone
means nothing. You have to balance it with a good investment. Anyone can pay a high yield out of capital. A
high yield is often an alarm bell not an asset.
If it goes up a lot before the dividend sell it. Cash is cash whether it comes in income or capital gain. There
is plenty of money to be made trading stocks for the run up to results and the dividend without actually picking
up the dividend at all.