I must admit that even as a pretty serious dividend investor, I had never heard the term “dividend capturing” before. I always knew what it was all about, but had never heard an official term for it. I was doing some digging around for some keywords for investing blogs (us bloggers do that) and ran across the term and decided I must write about it.[ad#tdg-embedded]
What is Dividend Capturing
Dividend capturing is a timing strategy that puts an investor in and out of stocks at specific times. Essentially, an investor buys a dividend paying stock at a specific time, collects the dividend payment from that stock when it is paid, and then turns around and sells that stock the next day.
The thinking is that the investor walks away with the dividend payment, and any gain the share price had while it was held. Of course, if the share price went down you would lose, but the dividend payment is supposed to offset that small loss.
When Do You Buy to Capture the Dividend
The key to enacting the dividend capturing strategy properly is to buy the shares of the company as close to the ex-dividend date as possible (see this post on what ex-dividend means), most importantly before the ex-dividend date. If you own the stock before it goes ex-dividend then you ensure that you receive the dividend payment when the company pays it.
An Example of How it is Supposed to Work
Of, let’s say you buy 100 shares of a company for $10 per share. You pay $1000 to acquire these shares on January 23rd, which is three days before the stock goes ex-dividend. This stock pays a $0.50 per share dividend and because you owned it prior to ex-dividend you will receive the dividend payment of $50 into your account.
The day after the dividend money is in your account you sell the shares, which happen to now be $10.50 per share. In addition to the $50 you received in dividends, you also have made a $50 capital gain on the share price appreciation. Your profit now becomes $100 ($50 dividend + $50 capital gain = $100 gain).
However, as we know share prices do not always rise. Assume that instead of rising our stock declined to $9.50 and we still sell it after that dividend payment hits our account. We have now lost $50 on our shares but are actually even because of that $50 dividend payment we received ($50 dividend – $50 loss = even) . With me?
Sounds like a pretty nifty strategy at first doesn’t it? However, there are some pretty big problems with the strategy.
Why NOT to be a Dividend Capture’er
The problems with the dividend capture strategy numerous, but I have tried to summarize what I believe to be the main problems with it.
The spread will kill you – the spread is the difference in price between the asking price and the actual buy price. You rarely get a stock for exactly what you want and that difference in price erodes any profit you might make. The spread makes it very hard to make money over the short period.
In my example above, I never once discussed fees. In the scenario with the share price going up our profit is actually reduced because we would have to pay commissions for the buy and for the sell. Assuming that we pay $4.00 per transaction, our profit is reduced from $50 to $42.
In the second scenario where the share price declines, the picture is worse. Instead of simply breaking even, the investor now loses money because they have to pay the $8 in commissions. The $50 dividend payment no longer fully offsets the reduced share price. The investor is now actually down $8.
The final negative to this strategy is taxes. Sure, if the strategy is enacted in a tax-protected account then taxes do not have an impact. However, if this strategy is done in a taxable account then taxes will further erode any gains you have above the spread and fees you have had to pay.
Even with that nice dividend payment you get while holding the dividend stock, the additional expenses you need to pay offset any potential benefit with this strategy. Why not just select a good dividend stock and hold it and collect a number of dividend payments for years to come? This way you reduce your fees, the impact of the spread due to short term trades, and taxes you pay.