No. of Recommendations: 1
>> "Remember to strip out the effect of the 6% dividend that is due in a couple of weeks."
> "I only ever look at total return"
I will do my very best today to convince you there is genuinely much more to this idea than it might seem at first glance.
Sometimes, (A+B) really does not equal A + B. For many more reasons than dividend tax.
In fact I can offer *16* different practical reasons to pay attention to these large dividends and adjust for their effects.
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Firstly, I would say that when looking backwards, total return is a sensible measure (adjusted for 'risk' in the 'danger' sense of the word).
It's also perfectly sensible when projecting forward over a holding period using a model with assumptions (again, adjusted for 'risk', perhaps).
The first reason I draw attention to the dividend issue here, is that not everyone uses models of total return.
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Many/most investors just glance at the most recent annual/quarterly/semiannual report, or even the numbers from a screener/database, and get some value characteristics as a heuristic (either for investment, or to pick out where they will spend time investigating further).
For companies that pay small dividends or haven't been especially active with quirky corporate activity, that's fair enough, it won't make much difference.
But when a dividend is sufficiently large in % terms, it can distort the 'appearance' of a company.
That might cause someone to invest, not invest, look further, or not look further.
Perhaps if they're comparing P/E of company A with company B when deciding where to put money.
Of course, not everyone invests on P/E, dividend yield etc, but quite a few people do. I'm not judging either way.
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For example. If you were to take the price, P/E , fwd P/E, and dividend yield from the most recent results for Unite, you might get:
Price 448.60
Historic P/E: 448.60/47.5 = 9.4x
Forward P/E: 448.60/42.25 = 10.6x
Forward yield: 8.4%
Whereas in 3 weeks , 'all things being equal', it would be like this:
Price: 423.10
EPS: 47.5p
Historic P/E: 423.10/47.5 = 8.9x
Forward P/E: 423.10/42.25 = 10.0x
Forward yield: 8.9%
(plus some cash).
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In this example, an investor might mentally categorise Unite as an '8% yielding stock' today in terms of the dividend return it produces from a year of business, but it's more like a '9% yielding stock' at the current price in reality.
That's not a big gap, but some people might have a particular goal in mind for yield, or have something yielding 8% or 9% they're comparing against.
Unite Group themselves are actually an especially interesting example of 'this or that' decision making! I believe they are interested in buybacks currently because the return from buying their own stock is better than the best yield they can find on building new property (about 7.2% net initial yield iirc). So, if you were trying to guess which price they would lose interest in buybacks with a simple yield A vs yield B model, you'd come to a different guess depending on which yield you calculate them to have.
If you're on the threshold of whether to increase or decrease your position in a share, perhaps it may matter.
If you prefer to size positions equally for reasons of personal taste, you might account for the immediate return of part of the capital.
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There are also a remarkable number of practical real-world consequences to keep in mind.
This is just what comes to my mind as I'm writing today. Hopefully others on the board can contribute their own ideas.
1) When a stock has dropped quite a bit and is on the brink of dropping out of an index, a gap down of 6% from a dividend might be enough to push it out at just the wrong moment e.g. market cap weighted index. That could result in additional forced selling. Alternatively, it might push it *into* a value index.
2) If you use a screener filter to identify cheap stocks to investigate, you may not even realise the stock exists, if the value of the dividend pre-xd date is enough to nudge it out of the filter.
3) Depending on any capital gains tax bands / allowances / reporting threshholds that affect you, the discontinuity in the price might affect which band/threshhold you are taxed upon, or whether you have to file a tax return or not.
4) If you hold strong views about LTV ratios on REITs, it might affect your opinion about the 'true' LTV of the stock once the dividend is paid. Covenant breaches are funny, because they're like barrier options, if you breach even by 0.0001%, quite bad things can happen. So some people care about this a lot.
5) If you are a believer in Technical Analysis (I am not), the 'gap' of the dividend might fool you, or it might fool others.
I've seen stocks that were cheerfully steady in price for weeks, then suddenly there's a massive wave of selling in the 2 hours after a huge dividend was paid.
For example, a stock might have effectively already broken through some moving average in a bad way, but you don't see it on the TA graph. Because the dividend that has built up was hiding it. Suddenly, everyone notices at once and reacts at once. Again, I don't do TA, I'm not judging, it's just something to think about.
6) If you trade options as a regular person (non-professional), you might misjudge the price of an option relative to the stock by not realising the stock is soon going to dive lower.
7) If you are the kind of person who uses stop-losses, a 6% gap down might trigger the stop loss accidentally when you actually had no intention to sell.
8) Conversely, limit buys, if you aren't paying attention to the date and the divi.
9) In the case where the large dividend is a special dividend, the apparent annual yield of the company in screener databases will go wonky to an extreme degree ('dividend' -> suddenly much higher, price -> suddenly much lower). This may affect decision making or simply finding stocks.
10) In the case of ETFs and ITs, changes in the timing of when the ETF pays dividends during the year can make the apparent index yield seem higher or lower. In the UK, many companies pay a 1/3 interim dividend and a 2/3 final dividend. Most UK companies pay that big dividend around May. So there's a big dividend in one quarter from the ETF too. If the ETF manager decides to move the payment calendar around, it can make one calendar year look good or bad. I'm pretty sure I've seen this in the past where you get '5 quarterly dividends' used by mistake in the calculated calendar year yield of an ETF. British ETFs tend to have quite high yields, increasing the chance of this issue.
11) As you note, dividend tax is an issue. 20% is a lot compared to 0% on capital gains, and in some countries, it's even higher than 20%. Scandinavia, usually 36-40% I think. Even in the UK, top rate on a REIT is 45%. For those people, if they happen to have discovered a share around the 'big xd' date, but delay making their new investment until the day after the xd instead of the days just before, they will get almost 3% extra shares! (6% x 0.45). And thus 3% extra long term total return, for a few days patience and a little bit of attention.
12) In some countries, unusual non-linear effects kick in when your income crosses a threshold value. The UK is famous for strange threshhold effects. A large dividend might just be enough to push someone's income past a limit. e.g. Buy X shares of stock A today, get the divi, and suddenly you don't qualify for free childcare any more. Buy X shares of stock A on the following week after the xd date, no problem (this year). I know of people this has happened to e.g. with a small company bonus. Google: 'childcare cliff edge'. It's a real problem.
13) OK, this one is kind of a stretch, but if you need to liquidate the portfolio in a hurry, 5-6% of your investment is inaccessible for a month or so. Not an issue for professional traders, but for normal people, who knows?
14) Emotions are real! (for most people). Waking up and seeing your stock down ANOTHER 6% instantly can be the gut punch that ruins a day, and worse, it can be the straw that breaks the camel's back and makes someone give up and sell, when really they're no worse off than the day before.
15) Another example of emotions - revenge trading. It's extremely common for people to resent not catching 'the bottom' or think 'wow, it's even more attractive, more more more!'. Big dividends can trigger accidental revenge trading.
All these kind of complications can make it important to pay close attention to stocks that pay >5% dividend at some point during the year.
The way I enforce this on myself in practice, is to always calculate the underlying price taking into account how much of the next divi / annual divi is accrued in the price. It doesn't make me any richer or poorer directly, it just reduces my chance of being caught out by some of these odd practical effects.
Can anyone suggest any more situations I haven't thought of?
TRS
