The dividend flow continues to be exceptional as we approach the end of dividend season, which is roughly coincident with earnings season, but a couple really stood out, making for a good case study in how to execute the dividend-capture strategy. The dividends are nearly identical, but the names could hardly be more different, creating a dramatic tension as to which is the best use of your capital.
On Feb. 27, both Lockheed Martin (LMT) and Lorillard (LO) will go ex-dividend, entitling shareholders of each to a dividend that is 1.3% of the current stock price. Lorillard will actually pay on March 11, while Lockheed will pay on March 29. If you consider stocks just a piece of paper, these dividends are identical twins. How to decide which one to capture?
The main principle to hold dear is that we do not have to make an investment thesis for either stock. We are not seeking capital gains, and we do not need the stock to go up. Similar to merger arb, our only goal is to avoid a loss. If we think we can buy the stock and sell it reasonably soon after the dividend at our buy price, then that is all we ask. As such, we are much more focused on technicals and other short-term indicators rather than the story. We don't ignore fundamentals, but they tend to play out over longer time periods, not the days or weeks that we intend to hold a stock.
With a focus on short-term technicals, we naturally go straight to the charts. In this case, Lockheed is looking far better. It took a dive earlier this year but has since stabilized. Since it has already absorbed a major hit, I feel more comfortable that it can hold around $88. Conversely, Lorillard has great momentum but this makes it more vulnerable to a reversal. With a rather large yield even after this run, clearly Lorillard is trying to not be an accidental high yielder, but I would still feel more comfortable if we were back at the levels of January.
Next I check the fundamental underpinning for the chart. Again, I am not trying to build a story, just feel comfortable that there is no risk lurking that could bite me over the next two to three weeks. Both names have solid EPS estimate trends that indicate no concern by analysts of a near-term deterioration in earnings power.
Both companies have reported earnings, so we eliminate the risk of a surprise news event during our holding period. (This will almost always be the case, as stocks rarely go ex-dividend close to an earnings release.) Lockheed reported an earnings miss on Jan. 25, which was one cause of the stock price decline, but did offer forward guidance ahead of current Street consensus. Meanwhile, Lorillard reported an upside surprise on Feb. 14, which featured sales growth of 7% on volume growth of 5%. Lorillard still faces the most regulatory risk, due to its high exposure to menthol, but this is not expected to impact sales in the near term.
Among the two names, the huge sentiment influence is obviously the sequester, which will impact the defense budget and the contractors as collateral damage. If the budget is about to decimate this group, however, you wouldn't know it from the stock price. For instance, look at the recent performance of the PowerShares Aerospace & Defense Portfolio (PPA). Appropriate to its name, it is on a rocket ride at the moment!
I suspect the reality is that because the sequester is in fact so small -- it will end up being only $45 billion in 2013, and much of the cut is a reduction in growth -- defense contractors will not be as impacted as many fear.
Weighing all the factors, you may be disappointed at my determination: I am playing both dividends. I entered long positions in both Lockheed Martin and Lorillard this week. I have higher confidence in Lorillard, as I play all the tobaccos every quarter and rarely lose on the trades. Conversely, there is still some sentiment risk in Lockheed Martin, but with that far-above-usual dividend yield and a chart that has bottomed, I am willing to take the risk on it.