The Supervalu (VLU) blow-up teaches an important lesson about dividends in general, as Jim Cramer has pointed out -- but it also highlights important tenets for our readers doing dividend-capture trades. Probably the most important element of dividend captures is choosing stocks with the right yield. For stocks with a tiny payout, your volume of trades needs to be unnaturally high in order for you to accumulate a satisfactory level of income. The temptation is thus to go for the highest yielding stocks. Capturing a 2% payout in a single trade, or even 3% or 4%, can entice even the most disciplined trader.
The problem with ultra-high yields is that it's signaling significant risk in the stock. Supervalu was at nearly a 9% yield when it paid its last dividend in June, far above its negative same-store sales. That high yield was indicating material risk. In similar fashion, to the consternation of some of my partners and readers, I have never played Annaly Mortgage (NLY), which has a 13% yield. It may or may not blow up, but I don't really understand its model well enough to take the risk of playing it.
An important positive attribute of dividend-capture trading is that you do not take the risk that was present in Supervalu -- that you could be holding a stock when the dividend is cut or eliminated. You will only be holding a stock after the dividend is declared. Clearly, you cannot hold it too long after it goes ex-dividend, or you could end up taking a number of unwanted risks: event risk, earnings miss, dividend cut and so on. But if you own it for only a few weeks at most after the dividend, you should not get hit with a sudden dividend policy change that could cause capital losses (especially if you are not playing a super-high-yield stock).
So keep in mind that you want to play names with yields in the safe middle: an annual yield of between 3% and 5%, which is reasonably high but not dangerously so.
On a separate note, I am fairly bearish on how European events are going to impact the U.S. market and economy, so I am restricting my dividend plays to economically stable sectors such as consumer staples. I am avoiding the highly volatile and riskier sectors such as industrials. On Friday I initiated trades on three plays: Proctor & Gamble (PG), Hormel Foods (HRL) and ConocoPhillips (COP). Energy is not a great sector at the moment, but with OK news from Chevron (CVX) and a lot of bad news priced in, I think I can scoot in and out of ConocoPhillips shares relatively painlessly.
