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.
Spread
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.
Fees
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.
Taxes
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.
Summary
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.
At the end of the day, dividend capturing isn’t investing. It’s speculating. And that’s why it’s a bad idea. And you’re right, trading costs will eat into the profit.
But I have to disagree with a couple of the other reasons you’re against the strategy:
1) Tax reasons: If you did this enough times, the capital gain/loss ratio would be slightly positive I would guess. The market does go up over time. So the only tax implications worth worrying about is the taxation of dividends, and they are, of course, taxed rather favorably.
2) “The spread will kill you – the spread is the difference in price between the asking price and the actual buy price.” That’s what limit orders are for. Or, if you don’t want to pay extra for the limit order, just buy a super liquid stock where spreads are never more than a penny. There are plenty to choose from.
Good points. You are rights that it is speculating. However, with regards to taxes, as soon as you sell you are hit with taxes. Granted, if you sell for a loss you get the capital loss to offset your gains. However, I think the tracking of taxes would be a nightmare.
This strategy is a waste of time.
If a stock is trading at 10.50 before the dividend, then after the 0.50 cent dividend is paid, the stock will trade at 10.00.
This is excluding all market factors.
So for no net gain in value, you get to pay a lot of commissions.
Anyone believing they are making any money at this is just really spculating on the market factors. There is no free money.
Dividend Capturing on a Diet.
I use an alternate form. Each month I invest a percentage of my take-home pay in the market. Each month I find ~3-5 stocks I could be happy with – perhaps already in the portfolio, perhaps new. One of the final tie-breakers is whether investing in this stock this month will capture a dividend — whether next month would be too late (for this quarter/year). I tend to be mid/long term in my buy-hold pattern.
I time purchases with consideration to price movement in the same way. All else being equal, price dip + upcoming ex-div is win-win.
Gordon Pape answered a question about exactly this strategy back in 2005 (http://www.buildingwealth.ca/q_and_a/Archives.cfm?StartRow=31&AYear=2005 – at the bottom of the page, I’m not sure how to directly link to the Q&A).
I agree with his perspective that the market isn’t stupid and the dividend being paid is reflected in the post-ex-dividend price (beyond any speculative movements).
I *THINK* the direct link is http://www.buildingwealth.ca/q_and_a/Archives.cfm?StartRow=31&AYear=2005#2370 (and the question’s name is “Collecting dividends”)
It sounds like market timing to me, at least in so far as trying to get the spread right.. I think I’ll take a pass. Besides, it runs counter to many dividend investor’s long term, buy-and-hold strategy anyway.
This is a tough strategy to make money at. Instead, you can invest in a closed-end fund that employs this strategy. See Alpine Total Dynamic Dividend Fund, ticker AOD.
One important thing to consider about taxes. You have to hold the stock for 61 days for gains to be considered long term capital gains. Same goes for dividends. If you sell in 60 days or less even the dividends will be taxed as regular income.
Been there….tried that.
First off in theory a stock should decline by the amount of the dividend once it’s paid. The “book value” does in fact do that but the market value won’t based on market factors.
First off my time is more valuable than trying to collect a 1.25% gain (assuming the annual dividend rate is 5%). On a $10,000 trade with a 1.25% dividend I’m making a gross profit of $125 less transaction fees it might be $100. Then you factor in the market changes over a single day and I might make more or less than $100.
I tried this trade using $10,000 on each purchase for 6 months while I recovered from surgery buying stocks that has an annual yield of 4% or more. After 6 months yes I had more than $10,000 but if I had invested $1000 in 10 of my favorite Cdn stocks yielding 4% or more and held them for the 6 months with no trading I would have had more and would not have wasted endless time at the computer.
Case closed for me.