A trading strategy for income

In this age of persistent low interest rates, the search for yield is on. DividendMax makes this search easier and more effective by comparing the yields of over 800 stocks globally and ranking them by yield. You can refine your search on yield and by index and sector, and filter the results on market capitalisation, dividend cover, consecutive annual dividend payments and forecast dividend increase. Below is a description of the main functionality that DividendMax has to offer:

Optimizer (stock selection)

The Optimizer uses forecast dividends across two, three or four dividends or across six, 12, 18 and 24 months. This solution looks at the scale and timing of forecast dividends and continuously calculates and recalculates the expected yield according to the price of the stock and the proximity to the ex-dividend dates. The slider functionality helps the user to select stocks according to the risk associated with the dividend payment.

From the Optimizer (as with all of the DividendMax functionality) you can drill down into the individual company details by clicking on the name of the company. If you hover over the dividends, it will give you a breakdown of the dividends to be paid and when. You can adjust your risk by selecting different yield levels, market capitalisations, dividend covers, consecutive annual dividend increases and forecast dividend increases.

Portfolio Income Generator (income planning)

The portfolio tool is used to plan for future dividend payments throughout the year. This powerful tool allows the user to select from all future dividend payments and to select a portfolio that produces regular income according to the user's specific needs. It calculates and displays the income per £1,000 invested. It also provides portfolio performance metrics and keeps a transaction history.

Countdown (dividend capture)

The countdown solution provides a list of all companies with dividends going ex in the coming three months. This list can be adjusted by index or by sector. The list will show the gross actual return on each dividend and the status of each dividend, whether an estimate or declared. This tool looks forward for a quarter and shows the type of dividend (interim/final/quarterly/special) and gives the yield of that particular dividend.

DividendMax is a disruptive tool that looks at dividends in a way that no other tool does because it potentially takes account of the timing of dividends over a timescale sufficient to render the ex-dividend factor irrelevant in the vast majority of cases.

David Jones, Chairman of and investor in DividendMax and ex senior proprietary trader in European and UK equites at a tier one investment bank, says: "In the past 10 years equity investors have had to trade stock markets, the strategy of buy and hold of the 1980s and 1990s is no longer the optimal one. Investors have to be proactive to achieve more favourable returns over the medium term. Given the uncharted economic territory we are currently in, this has never been more the case."

How are future dividends determined?

DividendMax predicts dividends according to the following hierarchy:

1) The companies stated dividend policy.

2) Average analysts. forecasts.

DividendMax performs these calculations against share price and expected ex-dividend dates every day against the FTSE 350 and a further 40 stocks not in the FTSE 350 that pay good dividends. The calculations also work for preference shares.

In response to some of the comments made by IC readers, DividendMax does not necessarily advocate looking at the next three dividends. It is our preferred timescale, but DividendMax covers varying timescales looking both backwards and forwards. DividendMax does not advocate dividend stripping or dividend capture; it advocates the setting of acceptable returns from income (dividends) and using this as a baseline for total return, which takes account of share price movements. We do not believe in the current market environment that long-term investing leads to superior returns. Most importantly, we believe that active trading leads to superior returns. We do not believe that the market efficiently prices stocks and we believe that large numbers of stocks are wrongly priced, be it overpriced or underpriced. Market anomalies are not difficult to find.

We also do not accept that there is a 'usual' strategy for looking at dividends or any 'accepted practice'. Our methods are deliberately meant to be disruptive in order to seek out and crystallise superior returns. In the final analysis, many investors are not following any strategy and are often driven by fear and greed. A powerful, returns-based strategy backed by income and willingness to trade actively are what we advocate for current equity market conditions.

Trading strategy for the income investor

At DividendMax, we employ something that we call the 'option' trade. The best trading strategy for the income investor is for them to decide on a level of return that they are happy to receive over a set period of time. DividendMax allows you to do this by using the Optimizer, which will look at forward dividends and their timing.

The 'option' that is referred to is to buy the stock and hold it for the appropriate period of time, safe in the knowledge that you are happy with the return. However, should your desired return come in sooner than you thought via a share price rise, then you can exercise your 'option' and take the desired return early.

The best way that we can successfully demonstrate the 'option trade' is to show how it would have worked with each of the dividends of the week that we have written for the Investors Chronicle. We will focus on our first 'dividend of the week', Admiral, published on the IC website on 1 July 2013.

At the time of publication the Admiral share price was 1,327p.

You expect to receive in that time income of 47.2p (18 September 2013) + 47.8p (7 May 2014) + 48.5p (17 September 2014) = 143.5p. This represents a yield of 10.81 per cent (143.5/1327), and is also the target share price growth to meet option trade.

To annualise this you will need to multiply by 365 and divide by 443, ie 10.81 x 365 and divided by 443 to give 8.9 per cent.

So 8.9 per cent is your target return. If you are happy with this return, then your investment can be made.

To secure the option trade, Admiral would need to rise to 1,445.1p at any time during the stipulated time period. That is 1,327 x 1.089. Admiral did rise almost 100p since being dividend of the week, but did not quite get to our desired return and so has not met the option trade. However, the current figures for Admiral suggest that the trade is worth another look. The stock fell sharply after eSure confirmed what Admiral had already flagged to the market, ie that motor insurance rates had softened considerably. However, we see no reason to reduce the expected dividends so let's run the Admiral numbers again:

The current share price is 1,287p.

The forecast dividend income remains unchanged at 143.5p (47.2p+ 47.8p+48.5p), but this now represents a yield of 11.1 per cent (143.5/1287).

To annualise this you will need to multiply by 365 and divide by 395, ie 11.1 x 365 and divided by 395 to give 10.3 per cent. This gives a new option trade target price of 1,419p (1287 x 1.103)

You will need to adjust the target figure of 1,419p for any dividend paid in the period.

Obviously, achieving the option trade quickly (ie within a matter of months) leads to outstanding returns, but our usual target timescale is 18 months. As you can see from the table below, two out of six dividends of the week have hit their 'option' target. Build up a reasonable portfolio of 'option' trades and you will have a solid trading strategy with returns that you have deemed acceptable.

Please note that the yield will vary all of the time as the price of the share changes and the ex-dividend dates are approached, and you may want to adjust your portfolio according to this.