'Renting' Stocks For Dividend-Dividend Capture

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. Let's 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, let's 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 a different perspective - which is very constructive.

Comments

[fatcat]

methinks a chart over maybe 3-5 yrs would be more useful.

Lame,as it is.

[dectra]

interesting idea....

[Paul E.Meisel]

We played around with this in an investment class in graduate school 30 years ago. The correct class answer was that markets are efficient, but students were able to create examples similar to yours.

I wouldn't think much of it as a mainstream investment strategy, but if someone took 10% of their portfolio to do this as a hobby, that could make sense -- more as an intellectual exercise than as an investment strategy.

[d_teller]

Neat article. But take a chart of AOD or AGD or ADVDX, and plot it vs the FTSE or SPY, and you can see how a dividend capture capital base erodes, even when it is managed by experienced people, in a declining market valuation environment. If one needs the dividends, and can tolerate 10-25% changes in NAV, then these CEFs and the Mutual fund, may have "value".

[misterchan]

Roger, your article is very interesting since I incorporate your subject material into my own investments. However, you missed up on one thing - it is my understanding that for the next two years, or DEFINITELY for the next year, DIVIDENDS ARE NOT GOING TO BE TAXABLE. tHAT IS WHY i AM TAKING ADVANTAGE OF THIS FACT AND PLAYING THE DIVIDEND GAME TO THE HILT. IT CAN BE PROFITABLE WHEN COMBINED WITH COVERED CALLS AND GOOD TIMING RE SELLING THE POSITION.

[RogerNusbaum]

d_teller, i hear you as I note that in a down market.... the other thing i might point out is depending on what site you are using to chart the funds it might not be accounting for the dividend. M-star is the only one I know that properly reflects the divs in their charts.

misterchan, not sure where you are writing in from but for US based investors the divs are taxed at 15% for now.

[misterchan]

Roger, Check it out. It was reported on the radio that for the next two years dividends will be excluded from taxes. Reliable source, just can't remember which one it was. Heard it on the radio. Also, someone called in and asked if they had heard it right and was reassured in the affirmative. Possible it was Bob Brinker, but I am not sure. I am writing in from Ca. Anyway, if it wasn't Brinker, it was someone with similar knowledge, as I don't believe everything I hear. Will be watching for some info from you.