Markets: Prepare for the dividend strip

Investors need to plan ahead if they want to benefit from generous dividend payments and avoid traps for the unwary.

It’s time to get organised. Westpac and ANZ both go ex-dividend in early November, so now is the time to start thinking about the joys of the dividend strip.

Although the market’s strength over the past year is being dampened by the prospect of the Federal Reserve winding back its quantitative easing program, the dividend strip strategy still holds true for some of the favoured companies of mum and dad investors.

Take Commonwealth Bank and Telstra for example, both of which went ex-dividend on 19 August.

It is natural for share prices to climb leading into reporting time, which is closely followed by ex-dividend dates. On the last trading day before 19 August, Commonwealth Bank had climbed 8.5 per cent and Telstra 9.2 per cent since July 1.

The day the stocks went ex-dividend saw Telstra lose 19 cents against a dividend of 14 cents and Commonwealth Bank $2.15 against a $2 dividend.

Although both companies lost more than the cash value of their dividends, once accounting for the value of the franking credits, investors were still in a better position (on a zero per cent tax rate). Franking credit wise, Telstra gave you 6 cents and Commonwealth Bank 85 cents.

The strategy of dividend stripping is best suited to self managed super fund investors, where the tax rate falls somewhere between zero and 15 per cent or other investors with low tax rates. But don’t forget you need to hold your shares for 45 days to collect the franking credits, where much of the value comes from.

Passing the holding period rule should be easy – you ultimately want to buy the shares a good month to six weeks or so before they go ex-dividend so you can benefit from the share price growth along the way.

Of course there are horror stories of buying a stock purely for the dividend and then it comes out with a terrible report and slashes the dividend. So you need to be careful and comfortable with the stock you do buy for the dividend, leaving the remaining banks to report as an attractive, viable option.  It is also handy to buy shares you would be happy to hold for the long-term, in the event of a significantly lower share price at the time the dividend is paid.

It is important to remember that depending on your transaction costs, you need to make sure you trade in a large enough parcel size so your costs don’t eat away at your profits.

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