In a previous article, I discussed three examples of companies that told the market of their plans to reinstate a dividend well ahead of time -- yet all three experienced a pop on the day of the dividend declaration.
In this article, I'll explore possible reasons for why the market does not fully price in these dividend reinstatement events ahead of time, and I'll note one company already discussing its dividend reinstatement plans.
First, it should be noted that just because a corporate officer says there are plans to reinstate a dividend, does not make it so. Fortunes for the company could turn south, or the economy could take a hit.
The possibility of the dividend reinstatement not happening could be a contributing factor but I don't think it explains the entire situation. All companies have risks and the threats described above could harm any company, possibly even forcing dividend cuts at current dividend-paying companies. Instead, I argue the next two factors have a larger role to play.
The term "income investor" fits a lot of different investing strategies ranging from the portfolio with a select group of dividend-paying stocks to the portfolio invested solely in dividend-paying stocks. Regardless, a stock with no dividend is not attractive to the income part of an investor's portfolio.
Income investors often have a more conservative investing strategy, and prefer to invest in companies already paying a dividend rather than speculate on the beginnings of a dividend. If an income investor likes a stock that is not currently paying a dividend, he or she may even take the approach of waiting for the first dividend to be declared and then placing a buy order.
In the case of General Motors and American International Group , by the time each company was signaling its intention to reinstate a dividend, both companies could qualify for a moderately conservative portfolio based on their size, valuations, and earnings. Even the airline-oriented investor would have Delta Air Lines near the most conservative end of the spectrum (in the airline industry at least) due to the carrier's debt reduction efforts. But in none of these cases did these stocks pay a dividend so income investors could not buy them for income purposes.
Dividend only funds
While dividend investors can still shift some holding into non-dividend stocks if they see an exceptional opportunity, many funds are set up under the guidelines that they can only invest in stocks that pay dividends. In these cases, the funds are held back until the dividend is officially declared; then they have the opportunity to buy.
The lack of a dividend keeps many income investors and dividend-only funds from purchasing shares of companies that have noted an intention to reinstate a dividend but have not officially done so. If these investors find the companies attractive, many wait, or are forced to wait, until the official dividend is declared.
At the same time as the dividend attracts new buyers now factoring dividend returns into their calculations, new money comes in from the sidelines creates enough buying pressure to push shares of multibillion dollar companies a few percentage points higher.
The next dividend reinstatement
With all the difficult parts of investing, the word of a future dividend reinstatement is among the easiest to find. In many cases a daily news search will turn up comments by company officials; after all, it's big news for any company.
For example, based on comments from company officials, Lloyds Banking Group looks to be on the path to reinstate its dividend. The British bank had to accept government funds during the financial crisis the gave the government a 39% stake in the bank. This stake has since been reduced to 33% and is expected to fall further as the government continues to wind down its holdings.
Lloyds has noted its intention to eventually pay 70% of its earnings out as dividends and has raised the possibility of a dividend reinstatement in the near future. The bank is working on filling a capital shortfall by selling assets before it is expected to ask regulators for permission to reinstate the dividend. With the dividend being seen as a sign of strength at many banks, a dividend could make shares of Lloyds far more attractive for bank investors and bring in income investors and dividend-only funds ready to make another banking bet.
Keeping up to date
It's important to keep track of what's happening to the companies you're invested in. That doesn't have to mean checking in every minute or even every day, but reading official reports and interviews from company officials can go a long way.
In the case of reinstating a dividend, the market has often underpriced this event as a lot of investment dollars wait until the official dividend declaration before getting in the market. Investors should always examine all aspects of a company before making a decision but when companies note their intention to reinstate a dividend, it could provide a nice boost to your returns.
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The article How to Profit From Dividend Reinstatements: Investor Behavior and a Stock That Could Pop originally appeared on Fool.com.
Alexander MacLennan owns shares of Delta Air Lines, and has the following options: long January 2015 $34 calls on General Motors, long January 2015 $40 calls on General Motors, long General Motors Class B warrants, long General Motors Class C warrants, long January 2021 $45 AIG warrants, long January 2015 $22 calls on Delta Air Lines, long January 2015 $25 calls on Delta Air Lines, and long January 2015 $30 calls on Delta Air Lines. The Motley Fool recommends American International Group and General Motors. The Motley Fool owns shares of American International Group and has the following options: long January 2016 $30 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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