May 08

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Safely Increasing Returns

A few years back, you could have picked up Bank of Montreal (BMO) for as low as $24/share. This stock pays a dividend of $2.80/share, but hasn’t increased it’s dividend in a while.

Now 10-12% return on a safe stock is nothing to sneeze at, especially in today’s ultra low interest rates, but what if we could boost those even higher with not much more risk?

Let’s look at a hypothetical trade.

Let’s say you managed to buy BMO at $28, giving you a 10% dividend.

Today, BMO is trading around $56/share, making the dividend payout 5% on any stocks you bought at today’s prices. You, however are still getting 10%.

If you can find a safe stock that pays higher than 5% today, you could sell your BMO stocks, buy that stock with the money, and increase your profits. So, let’s say ACME Corporation is paying 6% dividend (I had to make up a company, since I can’t find a safe, higher paying stock). You sell your BMO, and buy ACME paying 6%, you’re now making 12% return on the money you originally spent on BMO.

Confused? Let’s look at actual money.

You initially buy 100 shares of BMO for $2,800. Each year it would pay you $280 in dividends.

The stock has appreciated to $5,600, but still pays you $280, you haven’t put in any more money.

You sell BMO for $5,600, and buy $5,600 worth of ACME (your initial investment is still only $2,800), but ACME pays out $336/year instead of $280. $336/$2,800 = 12% return.

Of course, this would have to be done within a TFSA or some other form of account that doesn’t trigger the capital gains on the $5,600 when you sell to actually work, otherwise you’ll be taxed on $1,400 of capital gains, and some of the money would probably be withheld for taxes when you sold.

I’d also stress that you understand the company you’re buying into. For example, I did find Pitney Bowes was paying 8.8% as a dividend when I was picking names for this article, but I think Pitney Bowes, even though it’s an old company is dying (see Don’t bet on Dying Stocks). Just because you can do something, doesn’t mean you should do it.

Lesson: Sometimes there are ways to boost returns even when the stock market is flat, and no one is increasing dividends.

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