IN A world of high inflation, low growth and stock markets trading sideways, the investor is perpetually in search of ever-elusive income. Dividend income is understandably more appealing to the buy-and-hold investor community but the speculative trader should not ignore it either.
Dividends can still play a part in the contracts for difference (CFD) trader’s strategy and defensive, dividend-paying stocks such as utilities can be attractive in a recessionary, low growth environment.
Utilities stocks such as water and gas providers often pay out sizeable dividends, which are usually linked to the retail price index (RPI). For example, although Severn Trent last week announced that it would cut the interim dividend, its dividend policy will be RPI plus 3 per cent – a sizeable percentage at the moment. Inflation-linked revenues and consumers’ need for water and gas provision whatever the economic climate ensure that utilities have relatively strong balance sheets, allowing them to pay dividends.
To qualify for the dividend payment as a CFD trader, you have to be holding a long position in a stock on the day it goes ex-dividend. Most broker firms will pay out fairly quickly – in most instances within a week – but technically they can leave it until the payable date, says McCaig. The payable date can be as much as a couple of months – for example, Vodafone went ex-dividend on 17 November but the payable date isn’t until 4 February 2011.
The majority of brokers will pass on the dividend to CFD traders and spread betters holding long positions. After the 10 per cent dividend tax has been deducted, you would expect to get between 80 and 90 per cent of the gross dividend.
However, firms are not technically obliged to pass this on, warns Alastair McCaig, head of investment management at WorldSpreads, who advises that you check with your broker or provider first. Unfortunately, if you hold a short CFD in a stock on the ex-dividend date, you have to pay the full 100 per cent of the dividend.
Typically, shares in a dividend-paying stock will rise in the run-up to the ex-dividend date in anticipation of the announcement. On the day the stock goes ex-dividend, you would then expect it to fall by the amount of the payout. Some CFD traders employ a strategy known as dividend stripping, which involves buying a CFD just before a stock goes ex-dividend and then selling immediately afterwards. If the share price does not fall by the full amount then you will make a small gain, which can be leveraged up.
The tax treatment of the dividend should, in theory, also be beneficial. CFDs are liable for capital gains tax (CGT) at either 18 or 28 per cent whereas dividends are taxed at just 10 per cent. If you are likely to exceed your annual personal CGT allowance of £10,100, this is a way to reduce your liabilities.
Dividends are not and should not be the prime reason for holding a CFD in a particular stock but their advantages mean they should not be forgotten.