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JAMES FLANIGAN

Hot Wall Street Game: Capture the Dividends

February 10, 1988|JAMES FLANIGAN

Something strange is happening in the stock market. Stocks of companies that pay high dividends are being traded in extraordinary amounts day after day. On Tuesday, for example, there were 22 million shares of Consolidated Edison traded. On Monday, it was 29 million shares of Houston Industries--fully 25% of the Houston electric company's total stock.

And the phenomenon is not restricted to electric utilities--although being high dividend payers, they appear frequently on the New York Stock Exchange's most-active stocks list. Last week, 35 million shares of General Motors traded in a single day. This week, it's the turn of Avon Products, the door-to-door cosmetics company, which pays a healthy $2 dividend on a stock that sells for about $24 a share.

Yet, mysteriously, all that buying and selling didn't move the stock prices. On Tuesday, Consolidated Edison moved up only 25 cents, to $45.625 a share, despite trading of 20% of its total shares.

What is going on? The explanation seems as incredible as the event. Japanese insurance companies are buying huge blocks of stock just in time to qualify for the company's quarterly dividend.

But the reason the price doesn't rise with all that buying, is that the insurance company sells the stock almost as soon as it buys it--but with a time delay so that it can be registered as owner for a day and thus receive the dividend.

A brokerage firm, such as Nomura Securities, serves its clients by performing both sides of the transaction almost literally in the same second, so that the insurance company seeking to "capture the dividend" is not exposed to fluctuation in the price of the stock. "There is no risk in such business," a trader for Nomura says.

There also seems to be no sense, because the insurance company's instant sale of the stock is at a price reduced by the amount of the anticipated dividend.

Circumvents Law

But the method in such madness is to get around a Japanese law that allows insurance companies to pay out only dividend or interest income--not capital gains--to policy holders.

So, Japanese insurance firms with capital gains in their portfolios buy U.S. companies, which pay higher dividends than Japanese ones, and collect dividend income while taking a matching capital loss in the sale of the stock. It's a wash, in other words, and profitable only to the broker.

A complex procedure, and an American one. The Japanese companies picked up the idea of plucking a company's dividend from U.S. corporate treasurers who play dividend capture for profit--taking advantage of the U.S. tax law that says dividends paid by one company to another are 70% tax exempt.

That same tax law, however, says that for dividends to be exempt, U.S. companies must own the stock for 46 days. So many corporate treasurers got burned last fall when stocks they had purchased for a 6% or 7% dividend declined more than 20% on Oct. 19. As a result, reports Richmond, Va.'s Capitoline Investment Services, there has been some decline in U.S. dividend capture activity--although the business remains in the billions.

Big movers, big doings. What does it mean for the average investor, who might own a Houston Industries, Consolidated Edison or other utility stock in an individual retirement account?

Truth is, it means almost nothing directly. Avon, Houston Industries and other companies say the activity doesn't affect their dividend policies. And there is no tax-related or other economic reason for individuals to incur commissions and risk by rolling in and out of stocks on dividend qualification day--called the ex-dividend date in market jargon because after that date, until the actual cash dividend is paid, the stock trades without the dividend and thus, usually, at a lower price.

But indirectly investors might notice the values these days in dividend paying stocks. Houston Industries is paying almost $3 a share on a $33 stock, an 8.7% yield. Consolidated Edison is paying $3.20 on a $45 stock, a 7% return--with a possibility of capital appreciation that doesn't exist in a bank account.

The catch, of course, is that there is more risk to principal than in a certificate of deposit or money market fund--utility stocks fell just like any others in the crash, although most have recovered.

And investors might notice, too, that without dividend-related trading--which often accounts for a fourth of New York Stock Exchange volume--the stock market is pretty quiet these days. That's not a bullish sign.

Finally, investors and everybody else might take a long look at dividend capture. In Japan the powerful Ministry of Finance is about to put a stop to the game. In the United States, meanwhile, electric utility companies are big players of dividend capture.

Why is that? Well, because many utilities have excess cash these days. Electricity growth has slowed and there are fewer power plants to build. So electric company treasurers put the excess money to work earning a profit from dividends. Which is admirable.

But the question does arise whether that excess couldn't be more admirably used to lower electricity rates for the customers. Don't they deserve a dividend, too?

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