On Feb. 22 we analyzed two upcoming "twin" dividends, Lockheed Martin (LMT) and Lorillard (LO). Since they both went ex-dividend Feb. 27, it is now time to answer that age-old question: "How'd that work out for ya?" One trade was successful, and one not -- and it's counterintuitive which is which. The pair trade also offers an important lesson in the risks occasionally inherent in dividend-capture trading.
Despite the impending congressional sequestration, with its potential to hurt defense contractors, Lockheed Martin was almost too easy. The concern was that the stock would weaken as the sequester neared, preventing us from recovering our purchase price.
Your purchase price would have been $88.09, assuming you bought the stock at the closing price Feb. 22. Interestingly, the stock weakened during the week, but it then rallied strongly on the ex- date, again proving that going ex-dividend does not automatically mean the stock will drop by the dividend amount. (This is the anomaly that the strategy exploits.) By midday, the stock was easily above your purchase price, and your limit sell order should have triggered, netting you a juicy 1.3% dividend.
In contrast, Lorillard did decline on the ex-dividend date, as it usually does, but this was irrelevant to the trade because it was already down substantially from our Feb. 22 purchase price of $41.12 (on the close). As we had noted, Lorillard faced heightened regulatory risk vs. other tobacco names due to its high reliance on menthol, which is under heavy scrutiny by the Food and Drug Administration. The stock was hit that day, and continued its downward trajectory, in reaction to the naming of Mitchell Zeller as the new FDA tobacco unit chief. Zeller is a known opponent of menthol, and markets are factoring in greater regulatory risk. With Lorillard shares now down substantially, we may have some time to wait to get out of this one.
The Lorillard experience illustrates one of the points I made Feb. 22, and one of the general principles in dividend-capture trading: You do not want to hold a position when news could be reported. Obviously a great deal of news cannot be anticipated, and that is a general risk of the strategy, as we saw here. Where news can be anticipated, such as with an earnings report, stocks are best avoided and dividends should be sought elsewhere.
