SMSF Investment Strategy #2 – Generate Your Own Dividends
Many people buy stocks for their dividends which is a pretty sound strategy for Self Managed Super Funds (SMSFs), especially if your plan is for your super fund to provide you with income when you are retired. In the Australian market, bank stocks were a favourite among dividend seeking investors. Many financial planners were advocating buying bank stocks in late 2008 because they were generating dividend yields of close to 10%. The only problem with this advice was that dividends are not guaranteed and is usually a percentage of earnings. If earnings fall, dividends would typically fall as well so buying a stock simply because the dividend yield (based on historical dividends) looks attractive is not really a good idea. This certainly has proven true for bank stocks as banks have since cut dividends as earnings fell and they have also had to retain more of the earnings to provide for potential bad debts.
For me, I prefer to generate my own “dividends” rather than rely on the company to provide me with the dividends I want. Firstly, I would look for stocks in sectors that are relatively recession proof like consumer staples, utilities or telcos rather than finance. With banks, we still don’t know the how many more loans will become bad due to escalating unemployment and business failures, or how many more new capital raising they will need to do which will dilute existing shareholders. One stock I have been watching for a while is Telstra (TLS), Australia’s largest telecommunications company. When stock was trading in the $ 3 – $ 3.30 range, the dividend yield is around 8-9%. As this dividend is fully franked i.e. already taxed at 30%, the yield is easily over 10% for SMSFs who only need to pay tax of 15% instead of 30%. Although I like the Telco industry, I have been hesitant to buy Telstra before because I did not feel comfortable with the old CEO and his management team. Though it is still early days, I do like what I have read and heard about the new Telstra CEO. A stock valuation service I use also valued the stock at $ 3.09 so I am comfortable buying the stock at $ 3.00 or less.
In June 2009, I decided to sell some Telstra Aug09 $ 3.12 put options for a premium of $ 0.20. If Telstra’s stock price is less that $ 3.12 on 27 August 2009 when the options expire, I will have to buy the stock at $ 3.12 but the net cost to me would be $ 2.92 (3.12 – 0.20) which is a price I am happy to pay for this stock. If Telstra’s dividends stay the same, I will have a return of 10% on my money which is better than current interest rates. However, I am not counting on Telstra to maintain this level of dividends even though they have done so in the past two years. As Telstra is an optionable stock, I can very easily sell call options to get this 10% income even if Telstra pays no dividends at all that year. My current plan is sell call options to generate 10% income and assuming Telstra continues to pay the 28 cents of fully franked dividends, I could get a total return of 20% or more annually.
I am also pursuing this strategy with a few other recession proof stocks like Woolworth and CSL, which are optionable. My outlook for the Australian economy for the next year is for low or no growth. Hopefully, the worst is behind us but even then, I expect company earnings, even of the recession proof companies, to be stagnant so I do not expect much in terms of capital gains for these stocks. Capital gains would be a bonus but I am banking on getting my returns from both company dividends as well as the dividends I generate myself from selling options over these stocks.
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