I've always wondered whether there really is a way make money long term by renting stocks for the dividend-dividend capture as it is known. There are of course funds that do this but the results while generally ok over longer periods of time have been not so great in the last few months.
Before we get into this, even if it makes sense strategically it would be very tax inefficient so the context is in an IRA of some sort. Lets say the theory would be to put something like 50-60% of the portfolio in one of the total world funds and the rest would be used to rent stocks around their dividend dates.
To keep the math simple lets assume 3% into 15 names at any one time. A quick mechanics note is that on ex-date a stock price is reduced before the open to account for the dividend. For example a stock closes at $100 today. Tomorrow it goes ex-div for $0.50. If it closed tomorrow at $99.50 it would show unchanged. Obviously buying at $100, taking in a $0.50 dividend and selling at $99.50 is a waste of time and commission dollars.
The idea would be to buy before ex-date and sell it for at least what you paid for it after ex-date or in the example about buy at $100, take in the $0.50 and then sell for at least $100. So the stock would need to work back up to the pre-dividend price. In a healthy market this doesn't take that long but of course it may never make back the dividend.
Below is a list of real stocks with the name changed (we're not handing out fish here) along with the most recent dividend and the days needed to make back the ex-date reduction.
Enormous Domestic Bank 1.6% (this was the yield for the quarter, so annual 6.4%) made back the ex-div reduction in six trading days (intra-day)
Big Foreign Oil 5.4% (this was a once a year div) made back the reduction in six trading days
Hot Potato Shipping 1.6% (for the quarter) made back the reduction the next day
Fat Yield Foreign Tech 2.1% (for the quarter) made back the reduction in five trading days
Big Cap Telecom 1.1% (for the quarter) made back the reduction in 15 trading days
Good Ole Boys Tobacco 1.04% (for the quarter) made back the reduction in six trading days
Widows and Orphans Electric 1.34% (for the quarter) 58 days and counting (the next div is right around the corner)
Emerging Market Bank 4.9% (annual) four days to make back the reduction
Big Global Health 1.1% (quarterly) two days to make back the reduction
US of A Chemical 1.1% (quarterly) five days to make back the reduction
Not So Big Chinese Company 5.3% (annual) 16 trading days to make back the reduction
Great White North Bank 1% (quarterly) made back the reduction next day (intraday)
Ginourmous Conglomerate 0.9% (quarterly) made back the reduction next day (intraday)
Non-Oil MLP 2.2% (quarterly) made back the reduction next day
Emerging Market Oil 8.1% (annually) made back the reduction in nine days
That's 15 names, one did not work and I was able to find these by only looking at 21 stocks. There is a long term upward bias to the market so it may be so that since I grabbed the most recent dividends and the market has generally trended higher in that time it appears to be working out. If I had done this two months ago it may not have worked out as well as now and to be clear a lot of ideas work when the market is in an uptrend.
These stocks listed above are real stocks but they would just be a sampling of what I think would be needed to to maintain a fully invested portfolio that presumably would turn over ever month. If all 15 of these paid in the same month (sorry but I didn't want spend all day building a database I'm not going to use) then the yield on this portion of the portfolio would have been 2.65% for the month.
Is that representative of every month? The argument no is because the list brings in several annual pays to which I would say there would be a few months in the year where you could really load up on annual pays.
If someone with the time and inclination to do this could muster 1.5% per month it would be a monster home run.
It is possible that certain CEFs and other sorts of investment products could work too.
How large would the data base of stocks need to be to pull this off? The example above is with 15 stocks. 15 times 12 is 180 stocks but obviously you could bring that number way down as most of the stocks pay quarterly and so they could be bought four times per year.
The flaws abound but there is not much realistic risk of a bunch of stocks like this (notice there is no undue sector risk relative to SPX) cutting in half all at once unless the overall market cuts in half. Of all of the stocks studied plenty dropped close to 20% with the market and only one, the Chinese stock, from the top down to the bottom dropped by 50%.
I am in no way advocating picking stocks just for the yield. Buying a stock without a thorough study of the company is straight up stupid. Obviously there would need to be some sort of exit strategy discipline. Widows and Orphans Electric has not worked out on this go around, probably because utilities in general have not done great, but nonetheless it has not worked. Holding for 58 days would not make sense, relative to the strategy because that's a long time to not capture another dividend which is the point of the exercise.
Obviously just because I had an easy time finding names that worked does not mean it would work in the future. There is an up-market logic that says it could work but there is no guarantee.
Another big risk that comes to mind is behavioral. For instance this could start out, in an up market, working just fine leading to a little more risk being taken, which might also work out, leading to a little more risk and the next thing you know you have six shipping stocks with colossal dividends and then the rug gets pulled out from underneath as was the case last year.
The human reaction of taking more and more risk when something seems to be working for a while repeats over and over.
This is not something I am going to do. I do not think it is a substitute for a diversified portfolio. I do think it is very worthwhile to explore crackpot ideas like this because it does provide the chance to look at portfolio construction from different perspective which is very constructive.
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15 comments:
I've been trying to use the dividend capture strategy in a different way. I'd appreciate your thoughts. My approach is pick an industry (I'm using utilities because dividends are relatively large and volatility is relatively low). I've picked 3 stocks that I think are solid and whose dividend payments are about 1% per quarter. Most importantly their x-dates are in three different monthly cycles. I buy one of the stocks before the x-date, capture the dividend, then hope for the "bounce back" and sell it. I then immediately buy the next stock before its x date. In this way I have a constant exposure to the utilities industry while yielding 12% dividend (1% each month). This does trigger 12 sets of commissions, which eats into profits, but not too badly if the transaction size is large enough (i.e total commissions of 2-3% ). That still results in 9-10% dividend return, and assuming these three utilities track to the industry average the same capital appreciation as the industry. So far this has worked as planned, but I have not been at it long, and have not tried to back test it. Your thoughts?
Your dividend capture is "Genius".
You are basically relying on the Will Rogers view of investing in stocks. Something about if they do not go up don't buy them. Your twist is going back up to where you bought them.
Everyone is entitled to a silly idea now and again so I guess this is yours.
Sorry if you think I am being difficult but to buy into this strategy I would have to believe there is a free lunch out there waiting for me.
anon 6:35, any strategy that involves holding a stock for a month is going to have an elevated risk profile. I would ask you what tells you you are wrong about a holding? As I say in the post its not a substitute for a diversified portfolio.
anon 6:47 it is pretty evident you skimmed the article and missed the point.
Lotsa fun, thanks. I own one of the dividend capture CEFs and, as you suggest, it hasn't lit the world up recently.
Think about a portfolio like this, though, that paid just 1.2% per quarter. Buy and hold to eliminate some of the risk and cost you mention. What you've got is income that exceeds the magic 4%withdrawal bogey that you and others advocate.
Add in upward market bias and well-chosen stocks that increase their dividends faster than inflation and I'm a pretty happy camper.
ISTR that one part of the alpine dynamic dividend fund (ADVDX) 3-part strategy is something like this; i.e., increased turnover w/ the specific goal of increasing dividend capture.
this is anon 6:35 - following up.
I usually follow the hold vs trade approach. I admit that holding for a month adds risk, but it seems I am starting with a 5% "margin of safety" (9% after fee dividend return by trading vs 4% dividend return by holding). Also these three stocks are likely very highly correlated so it seems like the risks related to timing is reduced. Anyway....I'm trying it with a small portion of the money that I would have allocated to the utilities sector anyway. I doubt it will either make me rich or break me, but I'm giving it a try in an attempt to add a little alpha to my utility industry allocation.
anon, 7:34
having a greater yield than the market makes sense for most of a normal stock market cycle (up a lot being the exception). If you can get 4% while maintaining a diversified portfolio that is great but it is very difficult to get that high a number and be properly diversified. a couple of sectors don;t usually pay much in the way of divs and too heavy in divs might mean a big overweight to large cap value, or larger cap anyway.
RW, I think that is exactly right about all div capture products.
Anon 6:35 given that context and without knowing you then I might posit that generic behavioral issues loom out there but if it works for you then who am I to say otherwise?
I'd be interested in seeing some backtesting on the dividend capture approach, but using leverage (options).
Given that many large cap dividend payers have active and deep options markets, you could do something of a 130/30 strategy to more efficiently optimize capital allocation. (Something on the lines of committing a fixed percentage of total capital to in-the-money options that are at least 3 months to expiration AFTER the x date, and investing the remaining capital in risk-free assets.)
If you selected the dividend payers with diversification across industries/sectors as a requirement, you could effectively maintain both a balanced portfolio approach and capture the income and mute the risk with the cash in risk free assets.
Maybe not as "crackpot" as might first appear...
Rick
buy deeps on ex-date (so this would be after it is reduced)?
My first thought is that the theta would really work against and big changes in vol for many dividend payers is unlikely you unless you go very deep but at what point does a deep not make sense and are you better off with the common?
what am I missing?
Clarification to my prior post:
You would buy the calls on the x-date. You are not intending to capture the dividend, just the appreciation (or re-appreciation) as the in-the-money call recovers the write down from the dividend.
By leaving 3 months to expiration after X date, the loss due to time value erosion (theta) would be minimal. The risk free asset would be the source of cash flow, if that was the objective.
a little beyond my scope but does the option market somehow factor this in? It factors in the div b4 hand what about after?
Interesting idea.
Further thoughts on using leverage (options) and the dividend recapture concept:
With deep in the money options, the marginal increase in vol is inversely related to time to expiration. By ensuring that 3 months post x date would remain till expiration, I think price volatility of the option would be tempered. Of course, if you fail to recapture and begin to approach expiration date that risk increases.
As for theta, the same relationship applies: greater time value decay the closer to expiration, with a marked increase somewhere around 35 days to expy.
As for profitability, a lot depends on assumptions, per usual. But if you were buying 4 names, 10 calls per name, 10 points in the money (minimum), and you selected low vol stocks, it might cost between $45k and $55k.
Assuming an average stock price of at least $65 (to increase likelihood of 10pts ITM calls), and a dividend yield rate of 3%, and a delta to the calls with 90 days (at least) time value and 10 pts in the money of 0.85, the math works out (I think...) as follows: 10 calls (x100) x 0.03/4 (quarterly div) x 0.85 (delta) x $65, or $414 less $25 RT commissions. About $390 per name ($1558 for 4 names) expected return on an investment of $55,000. Something between 2.75% and 3%.
To thoroughly analyze this, one would want to look at scenarios that include up/down/flat SPX, and test for the effect of Beta of the underlying. Low Beta, low vol names with good dividend history may not lose the full mark down of the dividend - or rather, you may not be able to rely on bottom-ticking the trade.
Still, this seems like an idea worthy of some serious scrutiny if one is confident that a hard bottom to the market is in. (That 200 DMA for SPX seems to be coming into play...)
The leverage feature makes this suitable only for a portion of one's portfolio, and accurate risk analysis sees the $50k per month as a $600k per year exposure (however unlikely...).
Rick
PS: Re: options market discounting/anticipating divs, I don't have the answer and would be interested in hearing from a serious options trader.
so Rick I guess you haven't really given this much thought?
I would think anyone exploring this would want to back test the hell out of this, my hunch is that down market it would have a lot of failures.
I mentioned looking at 21 stocks for this post, most of the failures came in foreign financials that pay once or twice a year.
One aspect that might be difficult to test for though would be slippage. How wide will the spreads be in the future?
I wonder if the answer could be a stock and option combo?
There's a very lively discussion on the Morningstar Dividend Investing board following on a Q&A with Jill Evans, who is one of the the co-managers of the Alpine dividend capture funds. For those who are intrigued by this strategy, her Q&A on Alpine's approach is worth a read.
You have this wrong. Dividend caputure is a tax strategy. For a 50 cent dividend the goal is to trade out of the stock 50 cents lower. You swap a long term capital gain (low tax rate) for a short term capital loss (higher tax rate).
Your method is some bizarre trading strategy that implies stocks go up after they go ex-dividend. There is no economic reason why this should be a particularly profitable short term trading strategy.
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