Buying shares of a stock just before its dividend is paid and selling it right after, in theory, seems like a sound investment strategy—in reality, it's often not. The buyer would get the dividend, but the stock would decline in value by the amount of the dividend. Why do stock prices decline right after the dividend is paid? Because markets typically discount the price of a stock by a corresponding amount after shareholders can no longer receive the dividend.
Key Takeaways
- Dividends are distributions of a portion of a company's earningspaid to shareholders.
- When a stock goes ex-dividend, the share price often falls by a similar amount.
- The market effectively adjusts the stock's price to reflect the profits distributed to investors.
The Dividend Effect
A dividend is a distribution of a portion of a company's earningspaid to a class of its shareholders in the form of cash, shares of stock, or other property. It is a share of the company's profits and a reward to its investors.
For many investors, dividends are a major point of stock ownership. Long-term investors look to hold stocks for years and dividends can help supplement their income. Dividends can be a sign that a company is doing well. That's why a stock's price may rise immediately after a dividend is announced.
However, on the ex-dividend date, the stock's value will inevitably fall. The value of the stock will fall by an amount roughly corresponding to the total amount paid in dividends. The market price has been adjusted to account for the revenue that has been removed from its books.
This loss in value is not permanent, of course. The dividend having been accounted for, the stock and the company will move forward, for better or worse. Long-term stockholders are generally unaffected. The dividend check they just received makes up for the loss in the market value of their shares.
Dividends are taxable. They have to be claimed as taxable income on the following year's income tax return.
Day Traders and Dividend Capture
Despite the downsides we've just discussed, there is a group of traders that are willing to undertake the risks involved with this dividend strategy—day traders. Day trading involves making dozens of trades in a single day in order to profit from intraday market price action.
Day traders will use what's known as the dividend capture strategy, or a variation of it, to make quick profits by holding shares just long enough to capture the dividend the stock pays. The strategy requires the ability to move quickly in and out of the trade to take profits and close out the trade so funds can be available for the next trade.
Because day traders attempt to profit from small, short-term price movements, it's difficult to earn large sums with this strategy without starting off with large amounts of investment capital. The potential gains from each trade will usually be small.
How Does Dividend Capture Work?
The term dividend capture refers to an investment strategy that focuses on buying and selling dividend-paying stocks. It is a timing-oriented strategy used by an investor who buys a stock just before its ex-dividend or reinvestment date to capture the dividend.
What Is the Yield on Dividend Capture?
The yield on dividend capture is the actual yield you get after accounting for taxes and transaction costs. It’s calculated by subtracting any transaction costs and the tax (where dividends captured via this strategy are taxed at the higher ordinary dividends rate versus the lower qualified dividends rate) from the dividend the company pays.
How Long Do I Need to Own a Stock to Collect the Dividend?
To collect a stock’s dividend you must own the stock at least two days before the record date and hold the shares until the ex-date.
The Bottom Line
While buying stock right before the dividend date and then selling may seem like a good strategy on the surface, it's often not. Essentially, the investor would likely break even due to the decrease in stock value after the ex-dividend date. Buyers would also still have to pay taxes on the dividend.
