Sometimes, while looking for stocks I’ll come across a stock that has a weird chart.
As you can see above, there are sharp drops after dividends are paid out, and then the stock recoups to its original price, if not slightly higher. This happens because of the nature of stocks that pay dividends. For every dividend that a company pays out to investors, the value of the dividend is deducted from the share price. Most of the time this deduction is barely noticeable, but stocks like DUSB are exceptions.
When I first saw this chart, I thought the best strategy would be to buy right after the dividend, sell right before the next, and continue this cycle. But is this strategy valid? We can test two strategies for stocks like DUSB: continuously buying and selling and just buying and holding.
Buying and Selling
Continuously buying and selling between dividend dates, and reinvesting could be a good way to compound your money. But we won’t know until we do the math. With an average growth between dividends of 0.43%, which they pay monthly, and an initial capital of $100,000, we can calculate the investment value at the end of 12 months as: 100,000(1.0043)^12. Computing this gives a final value of $105,235.34, which is a year-over-year increase of 5.24%
Buying and Holding
Because the drop in stock price is equal to the dividend paid out, they cancel each other out. So to calculate the return after a year, we can just use the simple interest formula. With an initial capital of $100,000, a monthly increase of 0.43% between dividend payments, and a period of a year (or 12 months), we get 100,000(1+0.0043*12). This results in a final amount of $105,113.76, or a 5.11% increase.
Comparing the two strategies, continuously buying and selling is the more profitable strategy. The buying and selling strategy has a slight edge because the gains are reinvested, compounding the returns. But the reality is that neither strategy is great. Year over year both strategies caused a less than 7% increase in capital. Investing the same money in the S&P 500 would return an average of 10% yearly, but can get as high as 30% in recent years. So if you come across a stock that moves like DUSB, unless there’s a crazy increase between dividends, it's not worth it to put money in it. This also reflects a larger lesson in investing. People love to find different gimmicks when looking at stocks, but often the most profitable investment strategy is the simplest.
Comments