Wouldn’t it be great if you could just collect dividends without suffering the volatility that comes along with stock ownership? The dividend capture strategy aims to do exactly that. The basis of the strategy is to hold a stock just long enough to receive the dividend. Fundamentally, it is an easy strategy to apply but it could be considered a gamble in practice.
The Basics
It is important to understand a few basic concepts before attempting to implement the dividend capture strategy. Firstly, dividends are a portion of a company’s profits that are paid regularly to shareholders. They are usually paid quarterly but they could also be paid monthly. Many investors rely on dividend growth companies as a source of income due to low volatility, low to moderate risk and competitive yields. The dividend capture strategy can be especially useful when a less attractive company pays a very attractive dividend. Thus allowing one to capture the generous dividend without assuming the risk of holding the company for any longer than required.
Dividend Dates
It is important to understand dividend dates to successfully implement this strategy. The important dates to understand are the declaration date, ex- dividend date, record date and the pay date.
Declaration date – This is the date in which the board of directors declares when the dividend will be paid and how much the dividend will be.
Ex-dividend date – This is the date in which investors must buy the stock before to receive the dividend. This is also the date in which the stock is supposed to be reduced by the dividend amount.
Record date – This is the date in which a company reviews its records to determine which shareholders are eligible to receive the dividend.
Pay date – This is the date in which shareholders will actually receive the dividend.
How It Works
Simply, buy a stock before the ex-dividend date and sell on or sometime after that date. After you have owned the stock on the ex-dividend date you no longer need to own the stock to receive the dividend. In theory, when a company pays a dividend the stock will drop by the amount of the dividend. In reality, there are three possible scenarios. These three scenarios will result in a loss, gain or breakeven outcome for the shareholder.
Loss – Company 1 is trading at $30 per share and declares a $0.50 dividend. The stock is purchased before the ex-dividend date and on the ex-date it drops down to $29 per share. This would result in a loss of $0.50 per share, the difference between the $1 loss per share of the stock and the $0.50 dividend.
Break even – Assuming the same scenario, Company 1 drops to $29.50 on the ex-date. This would result in a break even situation, no gain or loss. $0.50 loss per share recouped by the $0.50 dividend.
Gain – Assuming the same scenario, Company 1 stays at $30 per share on the ex-date. This would result in a gain of $0.50 per share. Stock price stayed the same with a $0.50 dividend.
The dividend capture situation aims to take advantage of the third scenario. Since it could go either way there is a certain amount of risk involved with this strategy.
Precautions
Before going out and trying to implement this strategy there are some things you should consider first. Taxes, brokerage fees and other market factors can be detrimental to profits.
Taxes – There are certain tax advantages for holding stocks long-term. Ordinary income tax will be owed on all the gains received from this method.
Brokerage fees – If you have a broker that charges per trade you’ll need to factor in the price of two trades. If your broker charges $5 per trade you’ll need to make an extra $10 to cover your buying and selling fees.
Market factors – There are an infinite number of factors that could affect the stocks price come the ex-dividend date. Acquisitions, law suits, interest rates, political factors, etc.
