A company’s dividend yield is calculated by the amount of dividends paid to shareholders during the course of a year divided by the share price. For example, if a stock pays out £2 in dividends over the course of a year and it trades at £50, then the dividend yield is 4 per cent.
One way to trade this income strategy is to use long CFDs. Even though you don’t own the physical stock, you are entitled to a dividend if you take a long stock position in a CFD before the ex-dividend date. Also, because interest rates remain low then the cost of holding a CFD to benefit from dividend payouts is fairly cheap.
There are some key things to remember when trading a dividend strategy, says David Jones from IG Index. You want to look for stocks that have remained fairly flat in recent weeks or look like they could be reaching a technical low or be about to move higher, that also have strong dividend yields in order to reap the benefits.
Some companies have dividend yields in the double figures, which can be tempting, but it’s worth noting that yields can also be pushed higher because of a falling stock price. For example, Man Group, the investment company, has a dividend yield of 12 per cent, but its share price has fallen by 30 per cent since the start of the year.
David Jones says that the best stocks to play this strategy are the traditional defensive stocks that tend to pay a reliable dividend, which includes utilities, consumer durables and pharmaceutical companies. For example, GlaxoSmithKline, the drug maker, has a projected dividend yield of 5.1 per cent this year. The stock has fallen by 8 per cent since January, but it has lagged its peer group and could be due a correction in the coming weeks.
This strategy worked well for investors in Vodafone last year. It paid a 6 per cent dividend and its share price rose by 10 per cent in 2009. Vodafone’s projected dividend yield for 2010 is also 6 per cent, and the share price could be one of the most resilient performers on the FTSE 100 this year as people upgrade to smart phone technology.
Investors should remember that the stock price is not the only game in town.