The Dividend Capture Strategy

Looking for a way to invest in a stock and capture some free money at the same time? The Dividend Capture Strategy may be for you!

How Dividend Capture Works

For this income-oriented strategy, you buy a dividend stock just before the ex-dividend date and then immediately sell the stock on the dividend date.

This allows you to qualify for a dividend payment without the cost, or risk, of holding the stock for long periods of time.

Keep in mind that this is an active* strategy and requires you to be frequently researching and trading to employ.

(*That's the opposite of what we teach here at the Income Investors since we are investors not traders, but we love dividend investing and this is a subset of that strategy.)

If that didn't get you to lose interest in this strategy already, then here's the deal…

In order for companies to return earnings to shareholders, they pay dividends, or a sum of money paid regularly by a company.

Dividends are usually paid quarterly and they are always announced in advance.

Dividend Dates

There are two dates you need to be aware of when it comes to dividends. The Pay date and the Ex-dividend date.

Pay date

The Pay date is the day your dividend will be paid.

Ex-dividend date

The ex-dividend date or “ex-date” is the day the stock starts trading without the value of its next dividend payment.

The dividend is paid to the investor who owned the stock, the day before the ex-dividend date.

If you buy a stock on or after the ex-dividend date, then you're not entitled to the current dividend.

Here's a Dividend Capture Example

Let's put this in the context of two blue chip stocks, Caterpillar (CAT) and Boeing (BA).

Both stocks had an ex-dividend recently.

Here is a rough breakdown of what would go into a dividend capture trade if you had used this method on these companies during their latest ex-dividend date.

This example assumes you purchased the shares the day before the ex-dividend date and sold it the day of the ex-dividend date.

I have also included a $5.00 fee for the trade.

Every online trading platform has a different commission and fee structure, but I have used a rough average.

I have not included any taxes. These may be a factor depending on your circumstance.

For CAT’s most recent ex-dividend date, this strategy would have delivered a total profit of $19.20 or 1.43% yield on the initial investment.

There was $8.60 in total dividends added to a $20.60 profit from stock price appreciation.

Notice the fees for the transactions washed out all of the dividend payments. Boo.

Let’s look at the same stock but increase the shares purchased from 10 to 100.

In the ‘100 shares’ case, your profit has increased to $282.00 or 2.10% of initial investment.

However, you have to invest 10 times the capital. Boo.

Let’s look at another example from another company.

In the following example, BA pays a higher divided than CAT.

The investor would be able to buy 10 shares and the dividend yield wouldn’t be offset by the $10.00 total transaction fee.

In this example, the dividend captured was twice as much as the fees.

However, the stock price had dropped, leaving a loss of $59.40 from selling the stock.

The loss washed out any gains from the dividend capture but this trade could have been profitable if the stock was held longer.

Do You Have to Sell On Ex-Div Date?

There is no rule that says you have to sell the stock on the ex-dividend date.

The strategy would have the same effect if it was held for a day or a week or a month.

You could always hold on to it for a bit long and wait for the stock price to appreciate.

These examples are a very small sample size and may not represent a realistic effectiveness.

An investor who commits to the strategy over a longer period of time may have better success.

I chose these stocks because of their recent ex-dividend date to drive home the strategy.

OK, What Are the Risks?

Exposure to Cash

Dividend Capture requires a lot of capital to be sitting in cash, waiting for an ex-dividend date.

This could cause your cash to be sitting on the sidelines much of the time instead of working and earning.

Financial Theory

Theoretically, the price of any security should fall by the amount of the dividend on the ex-dividend date because investors who purchase it would know they wouldn’t be entitled to the dividend.

In practice however, stock prices sometimes rise on the ex-dividend date.

Time Commitment

You have to commit a great deal of time in managing all the trades and research.

Many investors either don't have (or don't want to have) the free time to apply this type of strategy.

Plus, once you start investing time, it ceases to be passive income.

And we are all about PASSIVE income here at the Income Investors.

Commissions and Transaction Fees

If you're considering using the strategy, fees and commissions are an importation cost to consider as they can offset any profits.

Tax Consequences

Selling an asset, that has been held for less than one year, may qualify any profits as a short-term capital gain.

Short-term capital gain rates are usually higher than long-term capital gain rates, which are levied on profits from assets you've held longer than one year.

Depending on the circumstances, a short-term tax rate can reduce, or even offset, any profits made from employing the strategy.

Dividend Capture Funds to Do the Work for You

If you like the strategy but feel like it's too much work (and it is), there are a few funds that employ dividend capture strategies:

Alpine Total Dynamic Dividend (AOD)

Wells Fargo Advantage Global Dividend Opportunity (EOD)

Rational Dividend Capture Fund Class Institutional (HDCTX)

Here are their returns compared to the S&P500.

Uh, yeah.

Theoretically, these are professional fund managers employing the strategy.

And even they haven’t been able to generate a positive return, let alone compete with the returns of just holding a S&P500 ETF.

However, poor performance could be the result of other forces than the strategy itself.

But you'll have to decide for yourself if it's worth the risk.

My Recommendation

If you really want to employ the dividend growth strategy, the safest thing to do would be to target stocks with low betas and large market caps.

Make sure the dividend yield is high enough to cover any transaction costs at a share amount that is affordable.

Blue chip stocks would be a great starting point, specifically stocks that aren’t exclusively trading on dividend news.

Apple (AAPL) and Proctor & Gamble (PG) would be good examples of this.

IBM (IBM) and Verizon (VZ) would be good examples of high dividend blue chip stocks that will offer a better margin if the price drops on the Ex-dividend date.

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