I am considering making monthly contributions to the Vanguard FTSE Canadian High Dividend Yield Index ETF VDY-T (VDY), which has a trailing 12-month dividend yield of about 4.4 per cent, a 10-year average annualized return of about 7.7 per cent and a management expense ratio of 0.22 per cent. The next dividend is scheduled to be paid on Oct. 7, and I was wondering: should I make contributions just before the dividend pay date? More generally, what are your thoughts about investing in dividend ETFs as opposed to individual dividend stocks?
Whether you are investing in a dividend exchange-traded fund or individual dividend stocks, there’s no advantage in purchasing your shares before the dividend pay date. Let’s look at VDY’s upcoming distribution to understand why.
On Sept. 20, VDY declared a monthly distribution of 21.2 cents a unit, payable on Oct. 7 to shareholders of record as of Sept. 27. Because stock trades take one day to settle, you would have had to purchase the shares no later than Sept. 26 to receive the next distribution. In this case, Sept. 27 is known as the ex-dividend date, because purchasers on or after this date are not entitled to the distribution.
I’ve heard from many investors who believe, erroneously, that it’s better to purchase stocks or ETFs before the ex-dividend date so they receive the next dividend. The flaw in this reasoning is that, all else being equal, the price of a stock or ETF will adjust on the ex-dividend date to reflect the fact the dividend is no longer included in the purchase. So what you gain in the dividend, you lose on the share price.
A stock rarely falls by the exact amount of the dividend and in some cases it might even rise on the ex-dividend date. That’s because many other factors also affect stock prices, from market sentiment and economic forces to company news. But the bottom line is that the market does not give investors a free lunch if they buy before the ex-dividend date.
With VDY, I’m more concerned about your plan to make monthly contributions. If you will be paying a commission each time you purchase additional units, this is not going to be a very cost-effective strategy. On the other hand, if your broker offers commission-free ETF purchases, as a growing number do, then your plan makes sense.
Now, to answer your second question, I’m a big fan of ETFs, dividend or otherwise. They provide an attractive combination of diversification and low cost that is especially appealing for people who don’t have the time or interest to manage a portfolio of individual stocks.
Another benefit of dividend ETFs is that, if a particular dividend-paying company falters – think Algonquin Power & Utilities Corp. AQN-T (AQN) or Corus Entertainment Inc. CJR-B-T (CJR.B), for example – your exposure will be limited. What’s more, you won’t have to fret over whether to sell or hold the stock in question, because the decision is out of your hands.
With individual stocks, on the other hand, when something goes wrong the financial losses are often compounded by emotional upset. If you’d rather not put yourself through the pain of seeing one of your stocks implode, then ETFs are an excellent alternative.
I was fortunate to be holding Canadian Western Bank CWB-T (CWB) prior to the announcement in June of its proposed acquisition by National Bank of Canada NA-T (NA). However, I don’t understand why CWB has been trading at a persistent discount of between 7 and 8 per cent to the proposed exchange ratio of 0.45 of a common share of NA for each share of CWB. Isn’t a discount of 1 to 2 per cent more common?
Not necessarily. It’s true that, in a 2004 study of 362 U.S. cash takeover offers between 1981 and 1995, the target company’s stock price the day after the deal was announced traded, on average, about 2 per cent below the bid price.
However, there was wide variation in this “speculation spread,” which ranged from 42 per cent below the initial offer price to 30 per cent above it, according to the study, which was published in the Journal of Corporate Finance and co-authored by Ralph Walkling of Ohio State University and Jan Jindra of Cornerstone Research.
A spread well below the offer price usually reflects substantial doubt that the deal will go through, while a stock trading above the bid price indicates investors believe a higher offer may be coming.
In the case of Canadian Western and National Bank, the speculation spread is somewhere in the middle. On Wednesday, National Bank’s stock closed at $127.30, and 0.45 of that number produces an implied takeover price of about $57.29. Canadian Western’s stock closed Wednesday at $53.16, for a discount of 7.2 per cent.
However, with the Competition Tribunal approving the deal on Thursday, investors are feeling more confident the transaction will proceed. As a result, the discount narrowed to about 5.5 per cent as of Friday morning.
The study also found that the length of time until a deal’s expected closing influences the spread, with shorter closing periods typically associated with smaller spreads, and longer periods leading to wider spreads.
National Bank’s acquisition of Canadian Western is not expected to close until the end of 2025, and given that a lot can happen between now and then, some investors may be reluctant to tie up their money for such a long period. What’s more, the transaction still needs approval from the federal Office of the Superintendent of Financial Institutions and the Minister of Finance.
Finally, the fact that National Bank is offering shares, as opposed to cash, introduces another layer of uncertainty. Any change in National Bank’s stock price – for good or bad – will directly affect the value that Canadian Western investors receive for their shares. This additional risk may be another reason that Canadian Western’s stock continues to trade at a mid-single-digit discount to the implied offer price, although that gap should narrow as the closing date draws nearer, assuming nothing goes wrong between now and then.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.