Maximizing Dividends and Deductions
Managing a company's working capital to achieve both safety and investment growth can be tricky. Ed Resch, president of $5-million Ohio Pipe, Valves & Fittings Inc., in Cleveland, keeps about half his working capital in a money-market account. Most of the rest is invested in a strategy known as "dividend capture," in which stocks are bought and sold according to elaborate schedules that maximize dividend payouts and tax deductions. "I wanted that money to be working for us now, building up investment income that one day I'll be able to use to help pay for my construction costs," says Resch.
Dividend-capture strategies take advantage of the dividends-received-deduction, which allows a corporation that owns dividend-paying stock in another U.S. corporation for at least 46 calendar days to deduct 70% of every dividend dollar received. "This means that if a corporation with a 34% tax rate owns stock and is taxed only on 30% of its dividend earnings, it will wind up paying about 10¢ in taxes on every investment dollar earned," says Warren D. Nadel, whose Greenvale, N.Y., brokerage house specializes in dividend-capture strategies.
There are different ways to fine-tune a dividend-capture strategy. Nadel minimizes his clients' loss potential by investing in preferred stocks that are typically less volatile than common stocks, and by making use of Treasury Bond futures put options to protect against the effects of interest-rate fluctuations, which could have a negative effect on the value of the portfolio.
This idea of principal protection is appealing. Preferred stocks behave in the investment market much the way bonds do: when interest rates rise, preferred stocks decrease in value, and vice versa. So Nadel designs his hedge -- the Treasury Bond futures put options -- to become more valuable when preferred stocks become less valuable. In 1990 that strategy worked well: while the average yield on CDs was 5.31% after corporate taxes, Nadel's dividend-capture portfolios averaged 10.3% after taxes.
Some points to consider: Since any dividend-capture strategy is subject to various market fluctuations, companies must be prepared to invest these funds for at least 12 months. And this is a pricey strategy, since many brokers require minimum dividend-capture investments of $500,000 to $1 million.
-- Jill Andresky Fraser