Franking credits....who cares?!

Ok morning grenade ;

Once upon a time franking credits were a bit of a free kick. Not really priced in.....so a real bonus right?

Now tell me these days what does the typical share price drop off at ex-dividend date represent for both unfranked and franked dividends? Is the drop off greater for franked divs? and roughly what is that drop off ?

Given the answer, aren't you just getting what you have already paid for in the share price already?

Discuss

 

So just buy more shares that arent franked and the income stream will be equivalent?

 

Ok - I am about to expose my complete lack of knowledge in this area.

XD price is just a point in time. If you buy shares - hopefully it's not for the short term. So the share price moving up and down a little should not bother anyone. But having the share price drop at XD - if you wanted to buy more - could be a good time to do it.

Over 10 or more years your buy in price remains the same. Your dividend is growing and your share price is all over the place (in an ideal world). I am not seeing that it's all that relevant to the really long term investor?

 

I've often thought about this and yes you really are just paying for your dividends when you think about it.

 

The drop off is not the issue, the issue is what the drop off reveals..(drop off is typically very close to grossed up dividend) that the SP is inflated by the expected value of franking credits attached to dividends. Hence, you already pay for the franking and it is no "free kick". This is something I am just coming to...as i had never really given it any thought.

 

No. I've done the exercise of spreadsheeting out the following:

Top 100 shares (by cap) that pay 100% dividend, opening price/mid price/closing price cum dividend day and opening price/mid price/closing price ex dividend day - for the past 10 years.


I was looking for a strategy to use to my own advantage by shorting the dividend strip, and picking up the 'perceived' amount the drops allowing for the franked component (which would be the profit of the trade).

What I found was in most circumstances was that you could reasonably rely on the mid price on cum dividend date to enter a short trade and pick up a small percentage of profit on the mid price on ex dividend day (Entry price - short sell price - dividend amount paid back = small profit). However, if you don't pick the mid price or better on either end of the trade, then there just isn't enough in it to successfully make the trade with better than 50% positive strike rate.

You would need good amounts of cash to trade this so the brokerage doesn't bite your slim margins - however, I believe it could be done reliably with some shares, but not all.

pinkboy

 

@Il Falco

 

This is not about any trading strategy, but coming to the understanding that the value of franking credits are already incorporated in the share price. When imputation was rolled out, drop off was around the value of the dividend itself, with no allowance for franking....over time this has now moved up to dividend + franking credit. To me this illustrates that the underlying SP on an ongoing basis is now adjusted for the value of franking credits....they arent free.

 

There are more. In due course. Time to think and my expand horizons by pushing things along... (this serves as a sounding board!)

 

I’ll leave ex-div moves to others but instead ask another –

If franking credits are a real return to investors, should investors specifically account for franking credit returns in dividend discount models?

 

I used to value infrastructure assets for a living - we would typically attribute 70% - 80% of the value of the franking credit. Assets were owned by superfund who love franking credits and it got even better for them (quite) a few years back when they could get a refund of excess franking credits.

 

Exactly the point of my exercise.....it proves its built in mostly, but not all the time.....and that was the edge I was looking for.

pinkboy

 

Yeah i guess you would gross up to allow comparison.

 

Cool. Mostly is enough for me.....this has been my experience. A few % short of fully "baked in" is neither here or there for my purposes.

 

A fundamental assumption in Black Scholes is no arbitrage. Therefore, if I could buy and sell shares with fully franked dividends to guarantee profit then this rule would be broken, which should not happen. Particularly with algorithmic trading.

I'd therefore have to confirm that franking credits are priced into share prices.

 

Yep, the free lunch has gone from a near full sandwich to a bit of crust kicked under the table.

Next topic will be dividends, but I need some more time for that

 

Pinkboy,

Out of curiosity have you done any work on the last 2 days pre cum dividend? Are there any patterns there with the price being chased up by those chasing the dividend?
Just thinking if this eases the pressure on getting the right side of mid price on a particular day.

 

Phew just get back from a break and find grenades still going off.

Quite frankly the only thing that I'm interested in is what eventually ends up in our bank account after tax. If I can get a better end result from an unfranked dividend I'll grab it. Generally what's most important is the "grossed up" franked dividend yield when comparing it with other income sources. But Total return needs to be taken into account when comparing assets to avoid falling victim to the yield trap.

If an Australian is choosing between shares here and overseas markets where there is no imputation credits (double taxation) then it is often said that an Australian investor is getting a free kick by investing locally. In reality rather than being a free kick, our imputation system is simply removing the double taxation penalty which exists in some other countries. However the theme of this thread is that franking credits are priced in but my view as explained below is that there "may" still be a partial free kick for local investors.

A consideration which might have some impact is significant International ownership of local franked dividend companies and the effect this can sometimes have on price. They don't get the benefit for franking so may not be as keen to pay this premium. However it seems there's some funny business that goes on between international investors and local fund Mgrs to extract value from franking to the benefit of both parties. Though the ATO warned against this a couple of years ago so I'm not sure if the practice is of great significance now.

The following research report appears to add support to the above:

Of course there will always be opportunities for the astute buyer where due to sentiment etc franking might offer a greater free kick at times but that's of little interest to the typical long term investor DCA into the market.

This article has some relevance particularly for SMSFs who sometimes fall victim to the lure of franking credits:
Franking credits: No magic formula for SMSFs

 

Cheers @austing . I too have found those old studies but I would love to find something recent. I'd wager that franking credits are near 80%+ priced in based on my limited anecdotal evidence

Anyway, this is all useful. Thanks.

 

Just curious for the interest in this. Is it for comparing franked vs unfranked locally or local vs International? The local vs International in particular also interests me.