6 Ex-Dividend Opportunities To Consider And To Avoid

Includes: ALE, CLF, EXC, HE, LLY, SJR
by: Paul Zimbardo

2012 has been exceptionally volatile for the stock market and the European situation is further threatening investments. With the economic and political climates only becoming more tumultuous I have been concentrating on high yield opportunities. Blue-chip dividend companies are well-known but there are attractive equities with high yields that are going ex-dividend every week. This strategy can work in one of two ways: either you buy before the ex-date to receive the dividend or buy after if the stock declines far below the after-tax amount of the dividend. Regardless of your short-term strategies, these funds can be attractive longer-term investments depending on your individual circumstances.

Buying the stock to receive the dividend is intuitive but many have contacted me requesting further details on the second strategy. Investopedia has a great example of how this works. To explain this, I will use AT&T (T) as an example. AT&T declared a $.44 dividend to shareholders of record on July 10, 2012. On the ex-dividend date the stock price should decline by the after-tax dividend amount, with an assumed tax rate of approximately 15% because many dividends qualify for a preferential tax rate. It is true that you can personally avoid immediate taxation by owning the security in an account with beneficial tax treatment but this serves as a benchmark.

As a result, an investor would expect the stock price to decline by $.37 = [$.44 * (1-.15)]. If AT&T declined by more than $.37 in the absence of negative news you might have an attractive opportunity. If you would like to be more conservative you can ignore the tax aspects and only trade if the stock price declines by the full dividend amount. Executing this strategy can generate returns over short periods of times but should only be performed on companies that you would be comfortable owning.

To focus on these opportunities I ran a screen with a focus on relative safety for the investments. I began with a specification of a dividend yield greater than four percent and an ex-dividend date within the next week. To provide some layer of safety I narrowed down the environment by looking at companies with market capitalizations greater than $1B, P/Es between zero and 20, and institutional holding percentage in excess of fifteen percent (except ADRs).

The overall objective is to concentrate on liquid companies that are affordably priced While not a precise requirement, I prefer companies that have underperformed the S&P 500 year-to-date as it indicates reduced downside relative to peers. With the impending European crisis I now pay additional attention to a company's geographical dependency and will avoid companies with significant European exposure. This is summarized below:

  • Dividend Yield ≥ 4.0%
  • Ex-Dividend Date = Next Week
  • Market Capitalization ≥ $1B
  • P/E Ratio: 0-20
  • Institutional Ownership ≥ 15%
  • Ideally Modest S&P 500 Underperformance
  • Minimal European Exposure

After applying this screen I arrived at the equities discussed below. Although I envision these as short-term trading ideas, you still need to be exercise caution. The information presented below should simply be a starting point for further research in consultation with your professional financial advisor before you make any investment decisions. My goal is to present new companies to you and provide a brief overview of their recent developments and this should not be considered a substitute for your own due diligence.

Consider: Iron Miners
Cliffs Natural Resources (CLF): 5.94% Yield - Ex-Dividend 8/13

Cliff Natural Resources is an international mining and natural resources company that is the largest producer of iron ore pellets in North America as well as one of the major producers of volatile metallurgic coal. Coal and iron may not be the most attractive investment areas in the United States currently but the company is expanding its operations to foreign markets to capitalize on the demand for iron and steel. After Cliff reported somewhat disappointing earnings on July 25th the stock declined from $42 to a low of $36 before rebounding by the close on Friday. The stock is approaching short-term overbought territory which causes some concern for dividend capturing but I believe still holds strong long-term potential. I have been trading CLF for the past year to take advantage of its volatility and strong option premiums; utilizing dividend timing can further boost your returns.

CLF is one of the rare stocks with a forward PE (4.65) lower than its dividend yield (5.94%) and the yield was well in excess of six percent last week. Analysts continue to recommend the stock and even the bearish analysts seem to have price targets above $50. The company has also recently experienced insider buying by three executives.

Avoid: Cable and Broadcast TV
Shaw Communications (SJR): 4.92% Yield - Ex-Dividend 8/13

Shaw Communications offers diversified entertainment services, but focuses primarily on Canadian cable television. Cable companies have traditionally been able to distribute sufficient cash flows to investors but the tides are shifting with the rapidly rising cost of content. Sports programming is a double-edged sword because it is one of the biggest advantages over Internet streaming; however, it is the most expensive for cable companies to offer. This is still a 'cash cow' industry but it is changing too quickly for me to fully support investing in it.

Factor in the popularity of Internet connected televisions and other devices and I am not extremely bullish on the traditional entertainment content business model. I do not believe that investors are being adequately compensated for the level of risk assumed and the other companies mentioned offer comparable (or higher) yields for less risk. Five percent seems to be that magic yield number for this type of utility companies that draws support and that could occur again with Shaw. The stock has underperformed the S&P 500 by over ten percent this year despite surpassing earnings estimates in the past quarter as revenue to be a drag. Note that Shaw pays dividends on a monthly basis.

Consider: Pharmaceutical Companies
Eli Lilly (LLY): 4.44% Yield - Ex-Dividend 8/13

Eli Lilly is one of the largest pharmaceutical ("pharma") companies in the world with drugs focusing on cancer, men's health, osteoporosis, and many other medical issues. Eli has one of the stronger pipelines in the industry and historically pharma companies have been able to maintain their high payout ratios so the yield appears to be safe. There is an abundance of coverage on Eli Lilly here on Seeking Alpha and the common theme is that Eli is a solid dividing paying company that generates sufficient cash flows.

2012 was predicted to be a difficult year for the company as it lowered guidance due to the patent expiration of Zyprexa but the stock has actually appreciated nearly 22% in the past year. Performance was better than expected due to strong sales of Cymbalta as well as Alimta which caused a revision to the previously lowered guidance. I still hold Eli for the very respectable dividend as well as what I consider above average gain prospects over the medium term.

Mixed: Utility Companies
Exelon Corporation (EXC): 5.46% Yield - Ex- Dividend 8/13
- 5.4M Customers in Illinois and Pennsylvania
Hawaiian Electric Industries (HE): 4.35% Yield - Ex-Dividend 8/13
- 1M Customers in Hawaii
Allete Inc. (ALE): 4.43% Yield - Ex-Dividend 8/13
- <1M Customers in Midwest

I recently wrote a detailed explanation of how I analyze utility companies and in brief I focus on the number of customers and geographic location. Larger companies enjoy scale benefits and are able to profit more from smaller rate increases. While geographical differences exist for regional utilities, underlying operations are essentially the same: a stable, cash-cow business that returns most profits to investors via dividends and share repurchases.

Exelon is the clear best of breed utility this week as it offers the highest yield, has the most customers, and operates in the most advantageous geographic region. Exelon was recently upgraded due to its ability to generate revenue growth in this difficult economy. On the other hand, Allete should be avoided because it has a much higher PE than Exelon despite having a lower yield.

Hawaiian Electric Industries is unique in that it completely monopolizes the state of Hawaii. The company and its subsidiaries service 95% of the state's population (all islands except of Kauai). Further distinguishing HEI is that the company operates a bank (American Savings Bank) which was responsible for nearly half of the company's income in 2011. 52% of the company's loans are for residential 1-4 family homes and total loans have been declining steadily since 2007. If you are looking to invest in a traditional utility I would avoid Hawaiian Electric due to its significant financial operations.

The information presented has been summarized below. Yellow and red represent "avoid" and "consider" classifications, respectively.

Disclosure: I am long CLF, LLY.

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