February is known as the earnings and dividend season for the Australian Stock Market. With an investor population that has become increasing yield focused, whether from safety or retirement perspective, in addition to having a wide variety of stocks that are paying more in dividends then you receive in the bank on term deposits, understanding the what, why and how of the dividend season is crucial for the Australian stock investor.
The next 5 top tips will give you some important points to consider during the ASX Dividend Season over the coming 6-8 weeks;
1. Check for Sustainability
Does the company pay a consistent and predictable stream of dividends? One of the easiest ways a company can destroy investor confidence, and in turn share price, is by dropping dividends. For this reason most companies avoid it like the plague. In your own research, it is always worthwhile taking note if a company has recently dropped their dividend, because it just might let you avoid nasty surprises not yet uncovered.
You can use the AIE Dividend Centre to look up historical dividends from ASX Companies. Looking at the last 6-10 dividends, you can check whether past dividends are stable, such as TLS’s 14c fully franked dividend, or whether there is consistent growth in dividends, like we have seen from the Big 4 Banks.
2. Is all that glistens really gold?
Many investors are lured towards enticingly solid dividend yields, especially with the franking credit system that is used in Australia, and with the declining rates on offer with term deposits. But while dividends are considered safe and stable, what are the risks of chasing such opportunities?
We all know the general rule; a company will likely fall by the value of its dividend on the open of the ex-dividend date. Sure, this makes sense because the cash is being transferred from the company to its shareholders. But what about the weeks and months after the dividend are released? Taking a look at history can provide some context and give you a head up of what’s possible.
Take TLS for example, one of Australia’s stable dividend payers. Looking back over the last 10 dividend payments, we did a review of the price activity that occurs in the 1 month following the ex-div dates. We found that on average, TLS can move a further 4.3% lower, on top of the price drop caused by the dividend. Worth knowing ahead of time to help you plan out whether to hold the stock, or sell the stock.
3. Protect Your Capital, Collect Your Income
A less common strategy that can be used in conjunction with dividend is buying Put options to create protection against price declines as outlined above. A Put option provides the buyer with the right to sell the stock at any time in the future prior to the contract expiration, and at a price (called a strike price) selected today. As with any protection (or asset insurance), there is a premium cost associated with buying Puts which must be taken into account.
Using Bought Puts however can provide investors with peace of mind and capital protection for time frames up to two years ahead. In some cases, the dividend income collected can even fund the purchase of your Put options, effectively paying for your capital protection. This is a great strategy for stocks that you may be a little less confident on.
When using Put options it is advised that you consult a licensed Options Adviser, and also to discuss tax implications with your accountant regarding franking credits.
4. Income Double Up
Investors may also look to pump up the income yields they can create buy Selling Call Options. By Selling Call options the stock holder offers up the right for another investor to buy their stock off them at any time before the contract expiration, and again, at a price (called a strike price) that is selected today. Typically Calls are sold on strike prices that are higher than the current stock price.
Selling Calls will cap the capital gains potential that are available on the stock. So why would you want to use this strategy? Because in exchange for the capped upside, at a level you have selected too, the Call Option seller receives an upfront premium income, boosting yield and providing partial downside protection on your stock holdings. This income, in conjunction with a paid dividend, can lead to considerable yield generation over a 1-3 month time frame.
It is advised that you consult a licensed Options Adviser when contemplating using Options in your portfolio.
5. Get reliable dividend info
Our final top tip for navigating through the ASX Dividend Season is to ensure that you have all the right information. A well informed Investor is a well equipped investor.
It is crucial to understand the difference between the ex-dividend date and the payment date, just as it is important to understand how to correctly use Options as part of your portfolio. Both education and having the right information tools is paramount to getting your way through dividend season safely. Both the ASX Website and the AIE Dividend Centre can provide you with some great resources and tools, ensuring you keep well informed.
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