We’ve talked a lot about long-term, old-school dividend investing. Buying stocks for less than they’re worth and holding onto them forever is a pretty time tested strategy. But I want to break away from the routine and talk about a little known strategy called – dividend capture.
Dividend capture is unlike any strategy we’ve considered so far. It’s extremely short-term and requires a little less research than usual. As the name suggests, it’s a strategy that seeks to find and capture dividends without regard for the long-term prospects of the company paying them.
Here’s what you need to know:
Dividend-paying companies pay out dividends periodically. Some pay them out monthly, while others pay quarterly. Dividends are the icing on the cake for investors who hold stocks. It’s part of the profits the company earns and can seriously boost the overall return from the stock.
But you don’t need to be a loyal investor to receive dividends. You can simply buy the stock one day before the dividends are announced and sell it after you’ve been paid. For this strategy to work it’s important to understand the way dividends are paid out. The process is spread out over four key dates, and timing is everything when it comes to a dividend capture strategy.
Four Key Dates
Dividends are paid out on a fixed schedule with four key dates. Here’s the entire process:
- Declaration date: This is the date of announcement. The company’s managers step out and declare a dividend. The amount is specified and so are the rest of the dates.
- Ex-dividend date: This is the day when the stock price is adjusted for the amount of dividend. So if the stock is priced at $10 and declares a $1 dividend, the stock will trade at $9 on the ex-dividend date.
- Date of Record: This is the date when eligible shareholders are recorded. Think of it as a list of shareholders who held the stock on a particular date and qualify for the dividend payment because of it.
- Pay Date: The date the dividend is finally paid.
As you can see, timing is crucial for this dividend capture strategy to work. In order to actually gain from buying and selling a stock, you need to know all the dates and trade at the perfect opportunity.
If you’re an astute observer, you’ll realize the system is designed to prevent a dividend capture strategy. You can’t qualify for a dividend if you buy on or after the ex-dividend date, which means the stock price erases any gain you may have had from the dividend payout.
But in reality the stock price doesn’t fully adjust for the dividend amount. So if a $10 pays out a $1 dividend, the ex-dividend price should be $9, but in reality it could be trading around $9.50. So an investor could invest $10, sell at $9.50, collect the $1 dividend for a total return of $0.50.
The dividend capture strategy is based on the volatility and unpredictability around key dividend dates.
The biggest advantage with the dividend capture strategy is the fact that there are simply so many stocks to pick from. There are hundreds of different stocks paying different rates of interest. Some of these stocks are well-known brands like Apple and Walmart, while others are lesser known but they pay incredible yields. These yields could be multiple times the amount of money you would expect from a savings account or CD. Another clear advantage is that this strategy is reliable. If you’ve read our monthly dividend income article, you know that some stocks pay out dividends every month. If you create a reasonable day-trading dividend capture strategy, you can easily generate a high return over the course of a year.
Finally, the advantage with a dividend capture strategy is that it doesn’t require much research. You can simply read up a little about the company, check the dividend yield, and figure out the payment schedule. There’s no need to understand the industry, the intrinsic value of the company, or the quantitative stock trading patterns.
A dividend capture strategy is not an easy way to get wealthy quick. There are several factors that limit the potential of this strategy.
The biggest disadvantage is the negative price adjustment. This mechanism of the stock market prevents a dividend capture strategy. If you buy a stock and only collect a dividend that covers the loss from selling the stock, you’ve wasted your time.
Another issue is the way these dividends are treated in terms of taxes. Some dividends “qualify” for capital gains treatment. This means they are taxed at a lower rate (15%) than your income tax rate for regular income. But for a dividend to qualify for this tax treatment the stock must be held for at least 60 days in the 121 days before the ex-dividend date. Holding a stock for so long makes the dividend capture strategy nearly impossible.
Unpredictability is another hurdle. If the stock price adjusts more or less than expected on ex-dividend date it could seriously impact the whole dividend capture strategy. So if the company you bought makes a major negative announcement on the ex-dividend date, the stock price could fall far below the amount you hope to recover from receiving the dividend later. Of course, the company could also make a positive announcement on the ex-dividend date that sends the stock skyrocketing. If the stock price gains and you receive a dividend your dividend capture strategy has performed better than expected. But it’s the volatility and unpredictability that should weigh on your mind.
Finally, brokerage fees could reduce the profits from this dividend capture strategy. Your trades need to account for the brokerage fees to make sure the strategy works. The only cost-effective way to pull off this strategy is to use an online broker with a flat rate of commissions.
The dividend capture strategy is very popular with short term day traders. It’s extremely difficult to pull it off, but if you time your trades properly and keep an eye out for taxes or brokerage fees, you may be able to complement your monthly income.