May was a bad month on the ASX, with the market down 7.3% (worst month since May 2010 … May strikes again!). I’m sure many investors are keen to turn the page into June!
Yesterday the market put in a decent showing with the XJO down a measly 12 points (-0.3% to 4064). Hardly significant or meaningful. However what got me thinking was some comments I received that the market “felt” a lot worse than it actually was. So I decided to examine the performance of the most liquid stocks (average value traded per day of over $5m). There are 111 such stocks. I then looked at the performance of the 20 “riskiest” stocks (measured by beta) vs the 20 most “defensive” stocks. The results summarise in the chart below:
Fairly remarkable. On a day when the market was essentially flat, risky stocks returned -2.9%, while defensives were unchanged. (Outperfomers included TLS and the banks).
Reasons I can suggest for this:
- The macro environment is obviously poor (negative headlines everywhere, Chinese data at 11am was also perceived negatively).
- The equity market is pricing in further interest rate cuts. In this environment defensive stocks will outperform handily.
I would suggest defensive stocks could be accumulated on weakness. On my watch list are property trusts and utilities that pay quarterly or semi-annual distributions in the last week of June (most of them but not for example WDC). I will also be looking at liquid industrial stocks that pay dividends in August and early September (eg TLS, CCL, WOW, AMC, ANN). Its important that the stock should be very defensive … this excludes mining, mining services, energy, consumer discretionary and media stocks for example.
I won’t be rushing though – last night the S&P 500 was -2.5%, the worst performance in 7 months. So there’s probably time to get set …
PS Investing and trading involves risk. Please read the site disclaimer.
What is it?
Dividend stripping is the process of buying a stock and selling it after it goes ex-dividend. The objective is to capture the dividend with the objective that the dividend (plus franking credits) exceed the losses incurred in holding the stock. Of course the stock makes a profit that is a bonus!
On 19 Dec 2011 I buy 1,000 TLS @ $3.23. Total cost $2,230 + brokerage.
On 13 Feb 2012 the stock goes ex a 14c dividend.
On the same day I sell my stock @$3.23. I’ve broken even on the stock, collected a dividend of $140 and collected $60 of franking credits which will reduce my tax when I lodge my return (note to get the franking credits I’ve had to meet the ATO’s 45 day rule … google for details). I’ve ignored costs in the is example. Note a breakeven is not guaranteed (YMMV).
In the good old (pre-GFC) days, dividend stripping was easy …. a rising market meant that the stock could be often be sold for about breakeven, leaving the dividend as pure profit! Given that some larger stocks can yield up to 10%pa including franking), this meant an easy profit of about 5% in 45 days (or 40% annually) with minimal risk!
What about now?
Unfortunately dividend stripping in general no longer works particularly well … it was a definitely a strategy for a bull market. A reasonably analogue is flipping residential property … most of the profits come from the rising market rather than the renovation itself. There are a couple of reasons why its stopped working but the most obvious that in a secular bear market (i.e. the current market), most of the return (actual and expected) is from the dividend. This applies particularly to high yielding stocks. In plain English, this means a lot of people are pretty stoked to get a total return of say 10-13% and gains above this level are arbitraged away.
My next post will look at how to trade for profit around dividends in the new environment.
PS None of the above is financial advice. Consult a professional before investing or speculating.