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calculating returns

Discussion in 'Shares' started by dkmc, 26th Aug, 2007.

  1. dkmc

    dkmc Well-Known Member

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    Scenario - If I borrow 100k from a line of credit
    and buy 100k of commonwealth bank shares

    dividend yield is 4.9% fully franked
    LOC interst rate is 7.5%

    Am I slightly negatively geared

    Income tax rate = 30%
    I am unsure how to calculate this
    I have the feeling that the true rate of return is 7.x % in income

    if growth stays at 10-20%
    is this not a good place to put borrowed funds.

    dee
     
  2. Rob G.

    Rob G. Well-Known Member

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    If dividends are fully franked then you effectively pay zero tax at a marginal rate of 30%.

    You will deduct interest expenses against other assessable income which gives a tax shield to the cost of 0.7 x 7.5% = 5.25% out of pocket on a 30% marginal rate.

    Provided capital growth (less any CGT you might incur if you plan on selling in the forseeable future) exceeds your net costs then you are ahead.

    However, capital growth is an assumption, and any forced realisation of assets such as from a margin call will trigger CGT and erode some returns. The CGT may be higher than you expect if it puts you into a higher bracket.

    Cheers,

    Rob
     
  3. dkmc

    dkmc Well-Known Member

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    so the negative cashflow is really
    5.25-4.9% = .35%??
    is this correct
    ie $350
     
  4. Rob G.

    Rob G. Well-Known Member

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    Assuming you are an Australian Resident, but ignoring Medicare Levy !!

    In your tax return:

    Dividend Income $4900
    Franking Credits $2100

    Less Interest Expense $7500

    Loss before tax & credits $500

    Now the loss after tax (deducted from other income) is 0.7 x $400 = $350
    And you get a $2100 credit off your tax bill

    Cheers,

    Rob
     
  5. Rob G.

    Rob G. Well-Known Member

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    Or look at it as returns BEFORE tax - even simpler.

    Just convert your franked dividends to pre-tax dollars because they are effectively tax-free

    Dividend = 4.9% / 0.7 = 7%
    Interest = 7.5%

    Net loss before tax 0.5%

    How does that sound ?

    Cheers,

    Rob
     
  6. Rod_WA

    Rod_WA Well-Known Member

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    And that's why I love CBA shares, too (I've said that elsewhere on this site).
    But it's probably not a good idea to only carry CBA, since all the big banks yield similar figures, and what if CBA turns out to have ugly sub-prime exposure or some other nasty event (think NAB foreign exchange problems a few years ago).

    But the simple calculations that Rob outlined represent a very neat way to invest; let me re-state this another way:

    A fully-franked share investment is self-funding if the dividend yield is 70% of the investment loan (LOC or ML) interest rate.

    (after franking credits and tax is considered, and the 70% is irrespective of tax rate).

    And this means that you don't care about market corrections (except for margin calls, if you're too exposed), since the earnings and dividends are bound to grow over time, and share price (capital) growth is yours for the taking some time later in life.

    And at 4.9% for CBA you're almost there. Brilliant. You might be interested (or not :eek:) to know that this is my primary investment criterion: if I can find high yield, fully franked, robust companies, I can purchase them without worry, knowing that the cashflow shortfall is small in the first few years, and will become income generating before long. That's why my largest holdings are CBA, WES, ANZ, GTP^, NAB and IAG.

    (I also have a rather large exposure to BHP, RIO and WPL, which are not high yield payers, but I'm a believer in resources, and a mix of stable dividend payers and powerhouse growth stocks is a good idea, I reckon; ^I picked up GTP at $2.20 a few months ago, on a FF yield of around 6.5% (that is, the tax man pays me to own them!))

    Sounds bloody lovely, music to my ears.
     
  7. pjb89

    pjb89 Active Member

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    Rod_WA

    So if your circumstances were such that you pay no tax (ie. working o/seas), how would the numbers come out?


    Pedro
     
  8. Rob G.

    Rob G. Well-Known Member

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    No witholding tax on fully franked dividends

    No franking credits

    NO TAX DEDUCTION FOR INTEREST EXPENSE

    Generally a bad idea for non-residents to gear into dividends, interest or royalties - unless you expect spectacular capital growth as widely held securities might not be subject to CGT for non-residents (but may be in your country of residence).

    Cheers,

    Rob
     
  9. Rod_WA

    Rod_WA Well-Known Member

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    Try this little spreadsheet, consistent with the calculations from The 'Bank Holiday' Portfolio Plan by Cameron McNeilage, published in the Eureka Report, Feb 21 2007.
     

    Attached Files:

  10. dkmc

    dkmc Well-Known Member

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    Thanks guys some great explanations here

    I think its a good strategy, that minimises risk
    Margin loan rates are a little too high for me 8.75-9% to do this

    But LOC/home loan rates are good for this strategy
     
  11. Elkam

    Elkam Member

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    Now for the all time newbie question.

    Where do you find the divident yield for a share... or do you calculate it?
    Is the yield you get not dependent on the price you paid for the share?

    Do you recalculate your yield if the share price goes up or down?

    I hope this gave someone at least a very good laugh. :eek:
     
  12. Tropo

    Tropo Well-Known Member

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    Dividend Yield - How to Calculate Dividend Yield
     
  13. Elkam

    Elkam Member

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    Great site. Just my level. Thank you.