Trading for dividends (DYP)

Interested in generating a regular dividend income?

A strong dividend income stream can be the cornerstone of an investment portfolio, especially where cash flow is crucial. Australian companies offer a relatively high dividend yield compared to their global counterparts, which investors can find attractive.

Active investors can participate in multiple upcoming dividends from various companies using the same capital investment. This is known as 'Dividend Yield Play' (DYP) - rolling out of one share, once ex dividend and into another for its dividend payment.  For example, the initial investment capital could be rolled six times in a twelve month period over six underlying shares, each delivering a dividend payment.

Instalments have added appeal when trading for dividends as they provide a leveraged exposure to the share while passing through the full benefit of dividends and franking credits.  As a result you are able to purchase an increased exposure to the share, boosting the dividend income stream from the same capital investment. 

The 'Dividend Yield Play' (DYP) strategy

The objective of a 'dividend yield play' is to generate a dividend income (and franking credits) from exposure to the instalments during the dividend period.  The desired outcome is to, at least, breakeven on the instalment trade while collecting the dividend and franking credits.

Currently ASX is conducting a portfolio study on running successive dividend yield plays on an initial $100,000 cash investment.  This study compares the results of using either instalments or shares.

Implementing the strategy

To implement this strategy you must purchase the instalments prior to the ex-dividend date. To be eligible for franking credits, you may need to satisfy the '45 day holding period' rule. This may also provide sufficient time for the underlying share price to recover after the ex-dividend date.

Deciding on which instalment is most appropriate generally depends on two factors.  The first is finding instalments that have an expiry or rollover date beyond the trading period.  The second is selecting an instalment with a gearing level that reflects your tolerance for risk.  The higher the gearing level the higher the risk.

Example

In August, QAN announced to pay a 9 cent fully franked dividend with an ex-dividend date of 01/09/2004.  As an alternative to buying QAN shares, you purchase the following instalment:

  • QANIZO - a regular geared instalment (59%)

The following table compares the absolute dollar income produced from shares and instalments on a $10,000 investment: 

QAN shares    QAN instalments   
No. of shares/ instalments 2,967 6,666
Buy price (28.08.04) $3.37 $1.50
Sell price (11.10.04) $3.41 $1.50*
Profit $118.68 $0.00
Dividends received $267.00 $599.00
Dividend yield (%) - not annualised 2.7% 6.0%
Total return $385.68 $599.00
Return on investment (%) - not annualised       3.9% 6.0%

* this price reflects the funding cost decay during the trade

This strategy demonstrates how instalments can enhance your income stream based on an equivalent capital investment. In percentage terms the instalments generated a 6.0% return compared to a 3.9% return on shares.

Points to be mindful of:

  • ’45 day holding period rule’ - to be entitled to franking credits you must hold your shares (or instalments) for at least 45 days. If you are claiming less than $5,000 of franking credits per financial year, the rule does not apply. You should consult your tax advisor, or you can refer to the taxation paper on the ASX website for more detailed information.
  • Plan and monitor trade - particularly after the ex-dividend date as the underlying price should theoretically drop for a period of time.
  • For instalments, accommodate for the interest and fee decay over the trading period.

Main benefits of the strategy

  1. Increased dividend income and franking credits.

  2. A small positive move in the share price leads to a higher percentage profit on the instalment.

  3. Less capital is required to receive the same dividend income than investing in shares. Alternatively you can generate more income for the same capital investment.

Main risks of the strategy

  1. The share price may continue to fall in the period immediately after the ex-dividend date (e.g. a fundamental change in the performance of the company).

  2. A small negative move in the share price leads to a higher percentage loss on the instalment. This is because the instalment is a leveraged investment.

  3. The more highly geared the instalment the more significant the funding costs.

Note: In some circumstances holders, although entitled to a dividend, may not actually receive that dividend in cash. For example, special dividends may, subject to the terms of issue, be used to reduce the loan amount rather than paid as cash to the holder. Likewise, holders of 'Self Funding Instalments' are entitled to a dividend although they will not receive it as cash. The dividend is used to reduce the loan amount instead.

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. All examples reflecting past performance is in no way an indication of future performance.