Fundamental Analysis: Dividend Trading

Trading for Dividends by Wise-owl.com 

(December 2005)

Strategy:  Dividend Yield Play over Zinifex

Did you know that you can gain full access to a company’s dividend and franking credits by holding its stock or an instalment for just 45 days? Many investors will opt for instalments as they offer leverage and require a smaller upfront outlay than shares.

This article is a quick run through the basics of what is commonly called a ‘Dividend Yield Play’.  This type of strategy can be used by both professional and retail investors to boost returns and dividend income in their portfolios.

How is it done?

Typically the strategy is implemented by purchasing instalments over a stock one or two weeks before the ex-dividend date.  This may allow you to secure a lower price as shares often rally as the ex-dividend day approaches. On the day the company trades Ex-Dividend the share price often drops by the dividend amount.  In the weeks following the Ex-Dividend date, given sound stock fundamentals the stock tends to recover the drop, allowing you an opportunity to unwind the instalment position crystallizing a dividend income stream and a potential profit.

Example Trade

Here is an example of the strategy Wise Owl covered in its research reports in late October 2005.

Zinifex (ZFX) announced on 25th August that it was paying a dividend and it was expected to go ex-dividend on 20th of October.  Given the strong fundamentals surrounding the company, after the announcement it was a prime candidate for the dividend strategy with the view that the share price would recover post the ex-dividend date.  Using an instalment for a dividend play you could have leveraged exposure to the dividend. Consult your financial adviser for further information on this type of investment.

Using Fundamental Analysis to Choose a Stock

Perhaps the easiest way to approach fundamental analysis is to think of yourself as someone who is about to purchase a business (in fact this is exactly what you are doing). Next, think of key drivers for the business and its growth in value. In the case of Zinifex (like most mining companies) key drivers of value (or share price) are profits and mine life. So how do these stack up for Zinifex?

Profits
Profits are what a business is left with after expenses; they can be paid out as dividends to investors or used to grow a business further. Zinifex has an excellent record of profits to date. Initially the company forecast a $63million profit for financial year 2005. Impressively it achieved a profit of $234million on the back of strong Lead and Zinc prices, showing a healthy business that’s experiencing strong demand for its products. This also indicates that management is not only meeting targets but tending to under promise and over deliver, a great confidence builder for investors.

Mine Life
Mine life is how long the mine will remain operational and is determined by the size and quality of the ore body underground. One way a mining company can be re-rated and experience share price growth is if it discovers the ore body its mining is bigger or better than expected. Of course this will only happen if it’s actually looking! The good news for investors is that Zinifex is looking. If you check its ASX announcements you’ll see an announcement dated 25 August called the ‘Preliminary Final Report’. On page 2 under ‘Highlights’ we see that a key part of Zinifex’s strategy is to grow through exploration. Only 3 months later an announcement dated 25 October gives us initial results that suggest the Roseberry Mine could be bigger than first expected. This is good news for two reasons: firstly management is building market confidence by meeting targets; and secondly the mine will be profitable for longer. Both of these can trigger share price growth.

Putting the instalments to action

With many instalments to choose from ZFXIMI was the most suitable instalment for this strategy by our accounts.  Executing the buy on Monday 17 October at $2.43, many investors will choose to hold the instalment for just a couple of weeks or until it recoups its dividend. In this trade however we ensure the entitlement to franking credits by holding for 45 days (see tax note below). The position was unwound on the 8th December at $3.19.

The following table compares the absolute dollar returns from investing $10,000 in the underlying share or the instalment warrant on the above dates.

ZFX ZFXIMI
Number of Shares / Instalments 1957 4115
Buy price on 17 October $5.11 $2.43
Sell price on 8 December $5.77 $3.19
Dollar profit $1,291.58 $3,127.57
Dividends received $78.27 $164.61
Total return $1,369.85 $3,292.18
% return on investment (not annualised) 14% 33%

 
While trading both the shares and the instalment were profitable the leverage of the instalment allowed a total return of 33% compared to the stock which returned 14%.

2005 Zinifex Share Price Before and After Dividend

2005 Zinifex Share Price Before and After Dividend

Important Taxation Consideration – The 45 Day Rule

The ’45 day holding period rule’ means that an investor must hold their shares or instalments for at least 45 days to receive franking credits. Investors who claim less than $5,000 of franking credits in a financial year are usually exempt from this rule. Consult your tax adviser for further information.


About wise-owl.com

Our team has years of experience with researching equity markets. Phillip Shamieh started the business in 2001, concentrating on very high net worth individuals.

Today, Wise-Owl’s focus is on providing retail investors with a greater insight into the Australian market.  Our philosophy is to combine fundamental, quantitative and technical analysis to create strategies that add value to an investor’s portfolio, irrespective of the market’s performance.

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Disclaimer
The information is for educational purposes only and does not constitute financial product advice. ASX does not represent or warrant that the information is complete or accurate. You should consider obtaining independent advice before making any financial decisions. To the extent permitted by law, no responsibility for any loss arising in any way (including by way of negligence) from anyone acting or refraining from acting as a result of this material is accepted by ASX.