My stock market research and recommendations focus on the area of dividend paying stocks, looking for those stock market investments that can provide attractive and steady yields during this extended period when fixed income investments like CDs and government bonds are paying very tiny yields. However, there may be times or you have set aside some investment cash with which you want to generate returns greater than the 5%, 6% or 8% you can get from quality, high-yield stocks.
Many of the methods you can find to provide “safe” double digit returns involve complicated strategies – such as dividend capture and/or covered calls – that require you to keep a close eye on your brokerage account and take unnecessary risks to the downside to earn a few more percentage points on the upside.
To avoid these complications and risks, I have developed a strategy that works counter to what the large crowd of dividend capture and covered call traders are trying to accomplish. I label the strategies as “low drag” from my years as a USAF fighter pilot. When flying, if you focus on performing maneuvers to minimize the drag factor, you save on energy, fuel and effort. The “low drag” strategy covered here will produce better returns with less time, effort and assumed risk on your part.
The Counter-Trend Dividend Swings Effect
For a number of stocks that have high yields and steady dividend payments, a trend develops that can be profitably traded without ever collecting a dividend. This counter-trend exists because of all of the dividend capture and covered call traders moving in and out of these stocks at the same time. The result is a self-defeating trading pattern for these traders and one you can profitably trade by going against the crowd.
When a stock goes ex-dividend, the share price drops by the amount of the dividend to be paid. After the ex-dividend date this type of stock will often fall further as the dividend capture guys sell off their shares. The share price will climb over the next several months and peak sometime between the next dividend announcement and the following ex-dividend date. This simple, but profitable, strategy involves watching for a low share price post ex-dividend to buy and selling at the peak prior to the next ex-dividend date.
As an example, Ares Capital Corporation (Nasdaq: ARCC) a business development company (BDC), pays a steady quarterly dividend producing an 8.8% yield. In four out of the last five quarters, the ARCC share price has followed the low-to-high swing pattern between ex-dividend dates with share value changes of 6.4% to 10.4% with and average swing of 7.8%. For the one quarter that did not swing, BDCs as a group where hit with negative market news and most dropped in value. ARCC still gained 0.6% from post ex-dividend to just before the next ex-dividend date. If you catch 75% of the swing each quarter you generate an average return each quarter of 6%, for a 20%+ annual return compared to the 8.8% dividend yield.
The ex-dividends swing trade can also work for more growth-focused dividend paying stocks. One that has shown a nice swing between dividends is Royal Dutch Shell plc (NYSE: RDS.B), an American Depository Receipt (ADR) of a foreign company trading on the NYSE. Since announcing its 2013 first quarter dividend on May 2, 2013 the RDS.B share price has gained 26%, closely matching the S&P 500, and shareholders earned an additional 4% in dividends for a 30% total return over 13 1/2 months. In contrast, the five ex-dividend to ex-dividend swings from May 2, 2013 through June 19, 2014 (currently holding shares for the August ex-dividend) have produced a 59% total share price gain, double the buy-and-hold strategy for RDS.B. Of course, you probably cannot perfectly time the buy and sell dates, but it is very possible to add a significant number of percentage points to the buy-and-hold return.
Running the Strategy
Here are the steps to run the counter dividend swing strategy like I use in my 30 Day Dividends service.
- Look at price charts of high yield stocks for a pattern of share price drop and then rise between ex-dividend dates. Usually, the pattern pops out at you when a stock shows this pattern. Here is the chart for ARCC as an example:
- Buy shares after the ex-dividend date when the share price has fallen from the day before ex-dividend by more than the dividend announcement. The low price usually occurs within 2 weeks of the stock going ex-dividend. Picking your entry point after the ex-dividend date is most of the “art” behind this trade strategy.
- Set a target sell price based on recent quarterly price swings. For example, with ARCC the target gain would be 6% above the entry price.
- Sell when the target price is reached or no later than the day before the stock next goes ex-dividend.
- This strategy can be used to accumulate shares of your favorite high-yield stocks. Add to your positions when the share price drops by more than the dividend amount post ex-dividend.
- If the desired share price swing does not occur during the two to three months between ex-dates you can choose to hold the shares, collect the dividend, and wait for a price gain prior to the next ex-dividend date. In this case it may take six months to hit your target gain, but you will earn a nice dividend as payment for waiting.
- You should have a list of several stocks that you watch for the dividend swing pattern. If for some reason the expected share price drop does not occur, do not force the trade.
- Use this strategy to boost returns in your IRA, where short term capital gains taxes are not an issue.
For the income investor this strategy can put some extra gains into your portfolio using a small portion of your capital. You may start to see the price swing trends from your longer term holdings and trade a smaller number of shares of the same stocks to take advantage of the swings.
This is one of several strategies I use in my new 30 Day Dividends service. The newsletter is new, but I’ve been using these strategies for years to “juice” my returns from dividend investments. If you want more stocks and strategies like these I invite you to check out my service here: the July issue is coming out in about a week and we’ve got more exciting dividend trade set-ups coming. Click here for more.