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Lower Stock Prices For Higher Returns

Aseem Chandawarkar, PhD

I dare not tell a long time holder of a dividend stock that the silver lining of the current down market high dividend yields on her stocks! That is the fallacy about valuing dividends – the effective dividend yield to
an investor is relative not to the current price stock, but to the price at which she acquired the stock. For an investor who acquired stock at a high price and held on to the stock through the downturn dividend payout percentage remains low, of reference is her purchase price. What makes matters worse is that many companies lowered their dividend payouts when their dividend yields started unusually high, given their current low stock prices is a double whammy for a dividend investor.

So, how can one benefit from the high dividend face of companies experiencing downfalls in stock prices, and consequently reducing their dividend payouts? Is this the right time to use cash to invest in dividend-yielding stocks?

The first order of business is to understand how dividends are paid. Typically, they are paid quarterly stock-holders “on record” on a date declared by the Board – this date is called the Record Date. As stocks
need three business days to settle, and one needs to own the stock three days before the Record Date, which is the evening preceding the Ex-Dividend D Anyone buying the stock on or after the Ex Date will not settle by the Record Date and, thus, will not qualify for the dividend. The dividend is paid on the Dividend Payout Date – typically, a few weeks after the Ex-Dividend Date.

Some foreign stocks pay dividend once or twice a year. Some ETFs pay dividend monthly to as “distributions”. Thus, depending on the frequency of the dividend payout, one needs to hold the stock only for one evening in that period to earn the dividend, and not for the entire duration of that time period. Then, why should we subject ourselves to the market risk for the entire time and, in uncertain markets like this year, stand to take a hit on the capital to continue to earn dividend?

The answer lies in the fact that a company stock theoretically falls by the amount of the dividend payout when it opens on the ex-dividend date. Additionally, it is subject to market variation, which may be upward or downward. The greed for earning the dividend by staying in the market for one night can reduction in the stock value.

There is, however, a way to protect the down side while fishing for dividends. This can be creating a near-market-neutral position with the use of equity derivatives – and protecting oneself on the downside to a reasonable extent. Such a strategy might require an investor to hold the stock for at most about a month to collect dividend while minimizing the
downside risk to the capital.

If this strategy is consistently applied, it allows the same capital to be utilized to collect dividends from different companies, as companies pay out their dividends on different calendars.

Food for thought … and, action!

(This article is reprinted from Monthly Newsletter by FuturOpt. FuturOpt specializes in the development of investment methodologies utilizing quantitative methods and contemporary trading technologies. )

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