It’s well known that share prices tend to move upward ahead of their respective dividend dates. Under the right circumstances this bias offers a great opportunity for earning some extra income.
As an example, take a look at the following Bank of Queensland (BOQ) chart. Each arrow denotes the ex-dividend date and as at writing we have another dividend coming up in late November. There are two points of interest here; firstly, the share prices exhibits upside strength ahead of the ex-dividend dates. Secondly, after that time prices decline by some degree or move sideways.
Now it’s important to understand that not every stock will travel this journey, and in certain market environments this is not a pattern worthy of trading. However, our research based on 15 years of price and dividend data across the ASX-20 universe shows a definite upside bias of around 63%. This may not sound like a lot, but a small edge like this, coupled with sound risk management, allows some nice profits to be generated.
The following chart shows a non-compounded view versus the growth of the All Ordinaries Accumulation Index (XAOA). On first glance this may not look overly appealing, but on closer inspection we can see some benefits. Firstly, the growth in equity is low in volatility providing a very palatable and low stress journey. That said, one can soup up the outcome by using leverage. Next, there is very minimal exposure to the market itself. We’re only interested in the month or so ahead of the major dividends and when they’re not in season we stay in cash and in comfort.
There is a time and place for leverage and whilst it can generate large profits, it can also lead to large losses. That said, because of the low volatility and exposure of this strategy, coupled with the relative safety of the ASX-20 universe, we thought it appropriate to investigate the use of leverage and dividend momentum. Below is the non-compounded equity growth vs. the XAOA using a Loan to Valuation Ratio (LVR) of 20%.
An important element of the strategy is how it avoided the GFC. This was simply because there was no momentum leading into the dividend date, and is an important reminder that one shouldn’t buy a stock simply because a dividend is coming up. A capital loss exceeding the size of the dividend will send an account spiraling backward – exactly what happened to many investors during 2008.
These charts show a variety of interest rate and equity market environments that provide a solid test of the strategies robustness. However, in the current environment of extremely low interest rates, is there a greater influence from this dividend bias? Our real time research suggests there is.
Since July 2013 there have been 30 possible trades within the ASX-20 universe. These trades must meet a certain momentum criteria and the company must exhibit a minimum 4% dividend, therefore the likes of BHP and RIO do not make the cut.
Of these 30 trades, the success rate of a rise into the ex-div date is 80% – well above the long term average of 63%. The average profit is over 3x the average loss which is also well above the long term average of 1.25 and if we look at it from a total return basis, since July 2013 through October 2014, excluding compounding, leverage and interest earned on cash, the return has been 17.6% vs. the XAO of 15.5%.
In summary, there is a definite and considerable edge to be found in the current low interest rate climate and I would suggest this bias will remain in place for some time yet. Even so, our research back to 2000 suggests this strategy offers a great vehicle for investors looking to add a little income to their existing portfolios.
Nick Radge is Head of Trading and Research at The Chartist. Nick has over 29 years’ experience in the financial markets. He has authored several books on trading and investing including his eBook, Profiting from Dividend Momentum.
IMPORTANT INFORMATION
Past performance is not indicative of future returns. The use of leverage can lead to large losses as well as gains and may not be appropriate for all investors. The material in this article is of the nature of general comment only and does not represent professional advice given by the author. All results are considered to be Hypothetical unless otherwise specified: Hypothetical performance results have many inherent limitations. Unlike an actual performance record, simulated results do not represent actual trading. Also, since the trades have not actually been executed, the results may have under or over compensated for the impact, if any, of certain market factors, such as lack of liquidity.