The Dividend Timing Trading Strategy

One method for combining technical and fundamental is a trading system based on the timing of a stock's ex-dividend date. This maximizes your return on capital through dividend yield, while also allowing you to move in and out of positions.

The ex-dividend date (also called the record date) is the day that stockholders earn dividends. Anyone owning stock before the preannounced ex-dividend date gets the dividend, although actual payment does not occur until several weeks later. Anyone who buys stock after that date does not earn the dividend.

When the ex-dividend date arrives, the value of stock is likely to drop to reflect the value of dividends to be paid out.

So if you buy stock timed to show you as the recorded owner as of the ex-dividend date, you will get the dividend but your shares will be reduced in value.

Key Point

The stock price will fall on ex-dividend date, so the key to this strategy is to pick exceptionally strong companies so the stock price will rebound sooner rather than later.

A strategy involving timing of purchases like this is clearly a trading strategy. The idea is to get in so that you earn the dividend, and then to get out as quickly as possible. Because the value will drop on or right before that date, you need to alter the strategy with a few trading rules:The dividend-based trading strategy uses timing of a fundamental (dividend) to increase short-term income through a trading system. It can create exceptional gains if you are using the same capital to move in and out of stock ownership positions.

Key Point

Timing stock positions to ex-dividend date means you earn the annual rate every month instead of every quarter. This means you can earn four times the stated annual dividend rate.

For example, assume that you have $5,000 to invest in 100 shares of three different stocks, all priced about the same and all yielding a 2 percent dividend each year. If you buy 100 shares of stock A before ex-dividend date, then sell at breakeven or a small profit within one month, the funds are freed up to repeat the trade in stock B, whose ex-dividend date comes in the second month. The same steps are repeated to move into stock C in the third month. Three stocks could be exchanged in this manner for the full year, maximizing dividend yield.

In this simplified example, you turn a 2 percent annual yield into a much higher annual yield by timing your moves. The quarterly dividend, 0.5 percent, is earned every month by moving money in and out of stock. That quadruples the annual dividend income to 8 percent instead of 2 percent.

Is this improvement worth the risk? To a conservative investor focused on fundamentals, it might not be. Such an investor will probably prefer to find a high-quality company as a long-term value investment paying a higher-than-average dividend and simply hold onto shares for the long term. However, a trader who is willing to take greater market risks will find this timing strategy very attractive and will be more willing to pursue it.

As with any trading strategy, the companies used to time dividends in this manner must be strong enough to rebound in price after the expected decline on ex-dividend date. The strategy works only if the best stocks are used for the strategy. Many high-quality companies yield an exceptional dividend, making this approach reasonable. The following chart provides an example of three companies for which this strategy could be employed. This is not a recommendation to invest in these companies, but only a means for showing how the strategy works.

[caption id="attachment_12784" align="aligncenter" width="559"]Dividend timing strategy Dividend timing strategy[/caption]

This strategy yields an average of 6.9 percent. However, actual annual yield, based on holding each stop for 30 days, would yield:

AT@T quarterly rate 1.75%
Pitney Bowes quarterly rate 1.65%
Altria quarterly rate 1.75%
average = 1.72%
12 months = 20.6%

Assuming that these positions could be entered and then exited profitably within one month, with each stock held for one month four times during the year, the total dividend yield would be 20.6 percent. This is impressive, assuming it worked out and not accounting for market changes during the year. This also does not account for potential capital gains or losses in each of the positions.

Key Point

The double-digit return from dividend timing can be even greater when you add in capital gains on the stock—or entirely wiped out when you experience net losses.

Because the changing value of the stock is itself an additional determining factor in whether this strategy works, it makes sense to employ this strategy in companies with exceptionally strong fundamentals; and only in periods when you expect an overall bull market. The strategy relies on the stock holding its value at the very least. Any increases in value add to the impressive dividend yield, but by the same argument any decline in the stock price can easily convert this into a trading loss.

If this strategy is compared to simply holding shares of all three companies, the market risk is identical, but the dividend yield is four times greater. However, the strategy is not for everyone. Traders will find it interesting, but it makes sense only if companies involved are first qualified in terms of fundamental strength and technical volatility.
By Michael C. Thomsett
Michael Thomsett is a British-born American author who has written over 75 books covering investing, business and real estate topics.

Copyrighted 2020. Content published with author's permission.

Posted in ...