Your Slice Of The Pie

One aspect of share ownership this is often overlooked is that owning stock means that you actually own a share of the company and are therefore entitled to a share of its profits.

That’s what a dividend is – a regular payment to shareholders representing their portion of the company’s profits.

Just be aware that there are no guarantees that a company’s board will approve dividends or of the amount that will be paid.

And of course, some companies don’t pay a dividend at all. It tends to be the big lumbering mature companies that return a portion of their profits to their shareholders this way.

The young upstarts that tend to grab all the headlines don’t usually pay a dividend. They need all their money to plough back into their growing business.

But, if you pick the right company, there is every likelihood that regular dividends will be paid out and the level of the dividend can be reasonably estimated.

It is certainly way more predictable than trying to pick the future price direction of a given stock.

In fact, it may surprise you to know that over the last 50 years, dividends have provided nearly half of the stock markets returns on investment (ROI).

The Impact Of Covid-19

The FTSE 100 contains many international players with excellent dividend yields and it’s quite possible to build a diversified portfolio with a yield north of 5%.

However, the events of early 2020 rather took a wrecking ball to the dividend payment of some of the biggest payers in the FTSE 100. When the economy was shut down to try and cope with the Covid-19 pandemic, an unprecedented number of companies suspended or cancelled their payouts in an effort to conserve cash.

This was a huge blow to those investors that rely on dividends for their income and share prices suffered accordingly. I believe many of these companies will restore their payments once the crisis passes, but for now, it has become harder to find solid companies paying sustainable dividends.

As an aside, that is one of the great advantages of selling stock options. We can still generate regular dividend-like income even when the original pay-out has been chopped.

The Key Dates

When a public company’s board of directors decide that they are going to pay a dividend to the shareholders, they are required to publish the details. The announcement covers the amount to be paid and includes three important dates.

Firstly, the date of the announcement itself. This is called the declaration date.

Secondly, the record date. That’s the date that a shareholder’s name must be on the share register in order to receive the dividend. In the UK, it is usually a Friday.

And thirdly, the date that they will actually pay the dividend to shareholders. This is called the payment date and is usually several weeks after the record date.

A fourth date is derived from the record date, and it’s the most important one for us to consider — the ex-dividend date.

This is the first date when a purchaser of the shares is not entitled to the dividend. If the record date is a Friday, then the ex-dividend date is the Thursday immediately before.

Apologies, if all that makes your head spin.

It’s actually pretty easy to work out, when you understand why the dates stack up the way they do.

In the UK, it takes two business days for a share transaction to settle — that’s T+2 in the lingo. In other words, if you buy a share today, your name will appear on the register in two business days’ time.

So, if the record date is a Friday, you need to buy your shares on the Wednesday to make sure that your name will appear on the register in time — and therefore ensure your entitlement to the dividend.

If you waited until Thursday to buy your shares, then your name would not be on the register until the following Monday. Therefore, the previous owners name would still be on the register on the Friday, and they would receive the dividend — not you. Hence, it is called the ex-dividend date.

If you are still confused, don’t worry. Here is a simple rule:

The ex-dividend date for a public company is widely publicised. Just make sure that you buy your shares before that date if you want to receive the dividend.

But…Tread Carefully

Just because you have found a stock that pays a good dividend yield doesn’t mean you can just jump in willy nilly. You see, the other very important thing to be aware of is how sustainable the dividend is.

The most common measure of sustainability is the dividend cover.

Dividend cover is the ratio of a company’s net income to the dividend it pays out. Or, put more simply, can the company actually afford to pay the dividend out of this year’s profits.

We ideally want to see a dividend cover of at least 2x. That would indicate that the company is earning twice as much net profit as it needs to pay the dividend. Anything, less than 1x is a concern as it implies that the company is earning less than it’s paying out. That’s not sustainable in the long run.

A recent report from stockbrokers AJ Bell states that the average projected dividend cover on the FTSE 100 stands at just 1.4x for 2020. However, on a positive note, analysts predict that company boards will not be in a great rush to increase payouts too soon after the pandemic recedes. Therefore, earnings cover should start to move back towards the 2x level we would like to see.

Another metric that is useful in predicting sustainability is the length of time that a company has been paying — and hopefully increasing — its dividend. If they have a long and proud history then the board will — in theory at least — be reluctant to cut it.

At the moment, there are just 14 companies in the FTSE 100 that have paid a rising dividend for the last ten years. That’s down from twenty-five at the start of the year. The culprit? You guessed it, Coronavirus.

Can’t I Just Grab The Dividend And Then Sell My Shares?

The dividend capture strategy is quite simple to understand, but harder to pull off.

The idea is that you buy the shares in your target company immediately before the ex-dividend date and then sell them either on the ex-dividend date or shortly afterwards.

By buying shares before the ex-dividend date, your name is on the register at the record date and you will receive the dividend. Then, by quickly selling the shares you alleviate the risk of holding them long term.

That sounds like a perfect strategy for an income investor. But, of course, it’s not quite that simple.

In theory, when a stock trades ex-dividend its price will drop by an amount equivalent to the dividend.

That makes sense. If you buy a £10 share the day before it goes ex-dividend then you are entitled to a dividend of, for example, 40p.

However, if you bought the same share the next day, it will have gone ex-dividend, and — in theory — its share price will have dropped by 40p to £9.60.

That would ensure that the price you paid was the same as if you had bought it the previous day and received the dividend.

However, in practice, this exact movement in the share price seldom occurs and that is why this strategy can work.

Proponents of dividend capture anticipate that the stock will not fall as far as expected. Or, that it will often bounce back to its prior level within a few days.

So, for example, if the shares open at £9.80 on the ex-dividend date, you could immediately sell them and take a 20p loss. But, that loss is less than the 40p you have made on the dividend you captured and so you are up 20p overall. Job done.

By repeatedly targeting shares that are about to go ex-dividend you can collect a continuous stream of dividends without ever holding onto the shares for more than a few days.

It’s a nice idea in theory but far harder to pull off in reality. As well as the costs involved there are no guarantees that the shares will play ball and their price could well move much lower than the dividend amount.

So, on balance, if you find a good dividend yielding stock trading at a good price then its probably better to simply buy it for the long run, or of course, use it as the basis for the FIRE Revolution strategy.