How to cash in on bank dividends

Each year, twice a year, it’s hunting season.

In the aftermath of the half and full-year reporting seasons, canny investors scour the market for some plump dividends, snapping up stock to secure dividends and then selling immediately afterwards.  This year, the hunt is on in earnest.

But, as any experienced hunter knows, those who arrive early usually walk away with the fattest prize.

Despite the enormous run on bank shares in the past nine months, financial institutions remain the primary target.

But there can be a catch for inexperienced players. To obtain the franking credits, investors must hold the stock for a minimum of 45 days. (It should be noted that the 45-day holding period does not apply where the total dividends received by an investor in a financial year is less than $11,667.) And research has shown that buying stock 45 days before the ex-dividend date can be far more lucrative than wading into the market the day before. Timing is of the essence, and the clock is already ticking down..

Research distributed by Goldman Sachs this week shows that, on an historical basis since 2000, holding bank shares for franking credits can be a lucrative endeavour when started early.

As an alpha generating strategy (delivering superior returns to the normal market), it has delivered 4% above the ASX 200 accumulation index on a grossed-up returns basis. That’s if you get in 45 days before the stock goes ex-dividend and sell the day after.

It’s a completely different story if you lose your diary and jump aboard at the last minute.

“Conversely, buying the day before ex-dividend and selling 45 days after has given an average negative alpha of -1%,” according to the research.

No need to be pedantic and point out that a negative and a minus cancel each other out. That’s why it is in quotation marks. Or that negative alpha is a contradiction in terms, a little like negative growth, another of my pet hate sayings. What on earth is wrong with terms like loss, shrink or contract?

But enough of that. The simple point is that buying late and being forced to hold on for franking credits could cost you money.

Why? It would not be unreasonable to assume that those jumping in late for the dividend inadvertently boost demand, which pushes stock prices higher in the final days. They are then constrained from selling in the immediate aftermath, thereby reducing supply. When they finally do sell, 45 days later, it comes in a rush, depressing the stock price.

So, ruling out other influences, the franking factor causes bank stocks to rise as the ex-dividend date approaches and gradually fall for 45 days afterwards.

Four out of the six big banks are due to pay dividends in the next 50 to 75 days. They include ANZ, Bank of Queensland, ANZ and Westpac. Unlike the Commonwealth Bank, which went ex-dividend on February 18, all report earnings outside the normal corporate reporting season.

So it would be prudent to begin hunting for dividends now, buying on any dips in the stock prices of major financial institutions.

Which bank is best? On purely a valuation basis, NAB is the cheapest with a 12% discount to the banking sector’s price earnings ratio, while the Commonwealth is the most expensive with a 13% premium to the sector.  But all pay handsome yields, although for the purposes of this exercise CBA is ruled out.

While it is undeniable that the 44% surge in bank share prices has driven the incredible rally on the domestic market since June last year, they still are relatively competitively priced and nowhere near the most expensive.

As a sector, our banks are priced at 14.7 times 2012 earnings and 13.4 times forward earnings. The health care sector, in contrast, is priced at 21 times forward earnings, while transport and gaming both are priced in excess of 18 times earnings.

Short sellers are notably absent within the banking sector, although what activity there is appears to be concentrated in Bendigo and Adelaide Bank, with about 2.4% of the outstanding shares the subject of short positions. ANZ is the least shorted bank in the sector, with short positions covering just 0.1% of its stock.

But the sector’s estimated 5.5% average yield remains its major attraction. And, if you can engineer a capital gain on top with a short-term play, so much the better.

*Clarification: An earlier version of this story referred to an exemption from the 45-day rule for fully franked dividends in a financial year of $11,667. It  should have read total dividends in a financial year of less than $11,667. The mistake was made in production.