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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