The Ups and Downs of the Dividend Capture Strategy
By Joe S Hannemann
The dividend capture strategy is a strategy where the investor purchases a stock for the sole purpose of collecting or 'capturing' the stocks dividend. On paper it is a very simplistic strategy; purchase the stock, receive the dividend, then sell the stock. Although, to actually implement the strategy is not as simple as it seems. This article will look into the 'ups and downs' of the dividend capture strategy.
To use this strategy, the investor does not need to know any fundamentals about the stock, but must understand how the stock pays its dividend. To understand how the stock pays its dividend, the investor must know three dates which includes the declaration, the ex-dividend, and the payment. The first date is the declaration, which is when the stock's board of directors announce or declare a future dividend payment. This tells the investor how much and when the dividend will be paid. The next date is the ex-dividend, which is when the investor needs to be a shareholder to receive the upcoming dividend. For example, if the ex-dividend is March 14th, then the investor must be a shareholder before March 14th to receive the recently declared dividend. Finally, the last date is the payment, which is when the investor will actually receive the dividend payment. If the investor understands these three dates, they can implement the dividend capture strategy.
To implement this strategy, the investor will first learn about a stock's upcoming dividend on the declaration. To receive this recently declared dividend, the investor must purchase shares before the ex-dividend. If they fail to purchase shares before or purchase on the ex-dividend, they will not receive the dividend payment. Once the investor becomes a shareholder and is eligible to receive the dividend, they can sell their shares on the ex-dividend or anytime after and still receive the dividend payment. Realistically, the investor only needs to be a shareholder for one day and receive or 'capture' the dividend, purchasing shares the day before the ex-dividend and selling these shares the following day on the actual ex-dividend. Since different stocks pay dividends basically every day of the year, the investor can quickly move on to the next stock, quickly capturing each stocks dividend. This is how the investor uses the dividend capture strategy to capture many dividend payments from different stocks instead of receiving the normal dividend payments from one stock at regular intervals.
Easy enough! Then why doesn't everyone do it? Well the market efficiency theorists, who believe the market is always efficient and always priced correctly, say the strategy is impossible to work. They argue that since the dividend payment reduces the net value of the company by the amount distributed, the market will naturally drop the price of the stock the exact amount as the dividend distribution. This drop in price will happen at the open on the ex-dividend. By this happening, the dividend capture investor would be buying the stock at a premium and then selling at a loss on the ex-dividend or anytime after. This would negate any profits made from the dividend. The dividend capture investor disagrees believing that the market is not always efficient, leaving enough room to make money from this strategy. This is a classic argument between market efficient theorists and investors that believe the market is inefficient.
Two other very realistic downfalls of this strategy are high taxes and high transaction fees. As with most stocks, if the investor holds the stock for more than 60 days, the dividends are taxed at a lower rate. Since the dividend capture investor normally holds the stock for less than 61 days, they have to pay dividend tax at the higher personal income tax rate. It can be noted that it is possible for the investor to follow this strategy and still hold the stock for more than 60 days and receive the lower dividend tax rate. Though, by holding the stock for that long of time exposes more risk and could lead to a decrease in stock price, eroding their dividend income with capital losses. The other downfall is the high transaction fees that are associated with this strategy. A brokerage firm is going to charge the investor for each trade, buying and selling. Since the dividend capture investor is constantly purchasing and selling stocks in order to capture the dividend, they will experience a high amount of transaction fees which could cut into their profits. These two downfalls should be considered before taking on the dividend capture strategy.
As you can see, the dividend capture strategy seems very simplistic on paper, but to actually implement it is a much different story. The most difficult part of making this strategy work is selling the stock for at least or close to the amount it was purchased for. All in all, to be plain and simple, it is completely up to the investor to find a way to make this strategy work. If the investor can do this and earn a profit, then it's a good strategy.
Joe Hannemann is an avid Dividend investor and creator of the free informational dividend investing website Power Dividends. Please visit the Power Dividends blog for current dividend investing information and strategies.