Profit From Short Term Dividend Plays

"The margin of safety is the central concept of investment. A true margin of safety is one that can be demonstrated by figures, by persuasive reasoning and by reference to a body of actual experience". Ben Graham

The Phisix’s 3.34% decline this week contravened the surge in global equity markets. This was fundamentally a function of the collapse in the prices of Meralco (-26.59%) and from Philippine Long Distance Telephone (-6.33%). Combined, the free floated adjusted market cap comprised about 40% of the entire index last week, and from this Friday’s close, this has now declined to about 37%.

Meralco’s unraveled its formative bubble the way we hoped it would [see Beware Of The Brewing Meralco Bubble!], and has spared the Phisix of the menace of a full blown bubble.

Meanwhile, PLDT’s decline was basically a function of the company’s dividend ex-date, where share prices adjusted to its dividend yields.

The Case For Dividend Plays

And dividend yields in today’s environment presents us with short term opportunities to dabble with in an increasingly “cash hostile, risk friendly” environment.

So instead of technical or chart reasons to go into the market, I will provide you with fundamental reasons.

Since it is the annual stockholder season, this likewise implies of the “dividend” season.

And corporate financial statements, especially by the heavyweight market cap issues or the “blue chips”, usually reflect on the conditions of the domestic economy.

Despite the unmatched deterioration in the economy as manifested in many of the corporate fundamentals by major public listed companies, even in the face of a steep decline in share prices, many companies will probably retain their previous scale of dividend payouts, which implies select companies with very impressive yields of more than 10%.

In short, depressed share prices with unchanged dividends will likely bring about outsized dividend yields! And this may prompt for a short bout of “yield chasing” by market participants after they are declared by the respective company.

Of course, the optimistic frame here is “unchanged”, because for the mainstream, a global recession prompted downshifting of the domestic economy should also account for a downside adjustment in most of the financial statements of the publicly listed firms.

While we agree that the economy could further weaken as a belated effect from the collapse of global trade last year and or in response to big increases in unemployment levels overseas, we are doubtful if the crash in share prices last year will equally be reflected on the performance of the corporate world.

Besides, our short term dividend play doesn’t consider the future but is a bet on last year’s performance.

On the other hand, what if instead of reduced dividends, a company, because of its strong showing last year in spite of the morose outlook, decides to hike its payout? We’ll make a guess; we get a catalyst for a short term run.

Nevertheless, if we are right about the Phisix drifting in a seeming “bottom formation” phase of the market cycle, then dividends can thereby represent as a “margin of safety” against risks of future price declines-because dividends represent as a value added factor for stock investments-can partially offset cyclical paper losses.

So from a short term perspective dividends can operate as a catalyst for a “short-term” run, and from a medium-long term horizon, dividends can be a cushion against further price decline pressures-our margin of safety-operating under today’s presumptive bottom phase.

Yet unlike the conventional market agents who react only after a dividend has been declared, the key to the game is in the anticipation of dividends. Of course, having a network of insiders could help a big deal.

So if we go by the premise of the short term “play” basis, we should start by looking at the company’s previous payout record and by vetting on its most recent financial statements, as we attempt to establish the speculative premise of whether the company will retain or even raise dividends. From here, we buy the target company before it announces its dividends.

And when the company announces and if they fall in line with our expectations, then we can expect the share prices to possibly surge in order to reflect mostly the rate of dividends which should adjust accordingly on the ex-date.

The dividend play means that we can “advance” the dividend by taking profit prior to the ex-date or as the price target reflective of the dividend level is met or wait for the dividend payout and hope for additional capital gains from the general market’s momentum swings.

The Risks And Recent Examples

Of course, one problem here would be the “timing” of the announcement of the payout. An early entry may reduce or if, fortunate enough, expand the scope of gains (see below examples of PLTL and PSE).

Another problem could be based upon wrong assumptions where the scale of the payout won’t occur.

Faced with such risk factors, however, if our assessment of today’s overall risk environment is anywhere accurate, then even wrong residual risk specific assumptions are less likely to equate to a disastrous portfolio.

For the many reasons cited above, the present environment, at worst may accommodate for a gracious exit with very minimal losses or even a breakeven. At best, if fortuitous enough, our exit might be accompanied by moderate capital gains.

In other words, the dividend play offers a far greater magnitude of gains than the degree of possible expected losses, basically from the premise of the margin of safety based on huge yields.

Over the past weeks, we have seen some of these dynamics at play. Here are some examples…

Figure 4: PLDT: Dividend dynamics

PLDT made its declaration of P 60/ share (special) and P 70/ share (regular) dividend last March 3^rd for a combined P 130/share. At the close of March 2^nd the company’s share price was at Php 2,175 or equivalent to a dividend yield of 6%.

The day from the announcement (blue arrow), the PSE’s largest company’s share prices rose to Php 2,310 basically manifesting the yield of the dividend. And on the ex-date (red arrow), share prices retreated beyond the price level. This sharp decline, however, appears to account for as an overreaction, as in the case of the PSE (below).

Figure 5: PLTL: Same Dividend Dynamics

Pilipino Telephone basically had the same dynamics with its parent PLDT.

The company declared a .52 cents dividend last March 2^nd where its share prices closed at Php 6.8 (blue arrow) or a yield of 7.6%. But share prices even rose beyond the rate of dividend yield but eventually fell back (even below the level from which the announcement was made) on the ex-date (red arrow).

But unlike PLDT, the company surged on 8.8% on Friday for reasons beyond the dividend play. PLTL’s experience shows that dividends can even compliment capital gains under today’s environment.

Figure 6: Philippine Stock Exchange: Dividend Play

As a last example, we see also the same dynamics with the Philippine Stock Exchange .

The non-banking monopoly finance company announced its dividend on February 25^th, which consisted of Php 3.65/share (special) and Php 4.35 (regular) or a total of Php 8/share. The share price on the day of the announcement (blue arrow) was at Php 129 for an equivalent 6.2% dividend yield.

Based on the said yield, the PSE should have climbed up to around to Php 137 per share. But it zoomed all the way to Php 147 a day prior to the ex-date.

While the share prices collapsed on the ex-date (similar to PLDT, red arrow), it quickly bounced back and was last traded at Php 138/share. This implies dividend plus capital gains from the original Php 129 level.

Finally, it is important point out that despite the sharp losses in share prices and a gloomy environment, two of the three issues mentioned above gave out special dividends, namely PSE and PLDT. In addition, while the overall dividends from the PSE (Php 10 per share adjusted on the 100% stock dividend) and TEL (Php 194- but may offer more at the second half of 2009) have been lower from last year, PLTL raised its dividend from .48 to .52 cents per share. Moreover, these issues dealt with less than 10% dividend yields.

Since it is the start of the dividend season, some issues seem as great opportunities from which we may be able to profit from based on this unorthodox tactical approach. If you are interested you can check with your broker if not you can write me by email (benson_te@gmail.com). But, except for clients, this won’t come for free.