Buying shares of a stock just before its dividend is paid and selling it right after, in theory, seems like a sound investment strategy—in reality, it's often not. The buyer would get the dividend, but the stock would decline in value by the amount of the dividend. Why do stock prices decline right after the dividend is paid? Because markets typically discount the price of a stock by a corresponding amount after shareholders can no longer receive the dividend.
Key Takeaways
- Dividends are distributions of a portion of a company's earningspaid to shareholders.
- When a stock goes ex-dividend, the share price often falls by a similar amount.
- The market effectively adjusts the stock's price to reflect the profits distributed to investors.
The Dividend Effect
A dividend is a distribution of a portion of a company's earningspaid to a class of its shareholders in the form of cash, shares of stock, or other property. It is a share of the company's profits and a reward to its investors.
For many investors, dividends are a major point of stock ownership. Long-term investors look to hold stocks for years and dividends can help supplement their income. Dividends can be a sign that a company is doing well. That's why a stock's price may rise immediately after a dividend is announced.
However, on the ex-dividend date, the stock's value will inevitably fall. The value of the stock will fall by an amount roughly corresponding to the total amount paid in dividends. The market price has been adjusted to account for the revenue that has been removed from its books.
This loss in value is not permanent, of course. The dividend having been accounted for, the stock and the company will move forward, for better or worse. Long-term stockholders are generally unaffected. The dividend check they just received makes up for the loss in the market value of their shares.
Dividends are taxable. They have to be claimed as taxable income on the following year's income tax return.
Day Traders and Dividend Capture
Despite the downsides we've just discussed, there is a group of traders that are willing to undertake the risks involved with this dividend strategy—day traders. Day trading involves making dozens of trades in a single day in order to profit from intraday market price action.
Day traders will use what's known as the dividend capture strategy, or a variation of it, to make quick profits by holding shares just long enough to capture the dividend the stock pays. The strategy requires the ability to move quickly in and out of the trade to take profits and close out the trade so funds can be available for the next trade.
Because day traders attempt to profit from small, short-term price movements, it's difficult to earn large sums with this strategy without starting off with large amounts of investment capital. The potential gains from each trade will usually be small.
How Does Dividend Capture Work?
The term dividend capture refers to an investment strategy that focuses on buying and selling dividend-paying stocks. It is a timing-oriented strategy used by an investor who buys a stock just before its ex-dividend or reinvestment date to capture the dividend.
What Is the Yield on Dividend Capture?
The yield on dividend capture is the actual yield you get after accounting for taxes and transaction costs. It’s calculated by subtracting any transaction costs and the tax (where dividends captured via this strategy are taxed at the higher ordinary dividends rate versus the lower qualified dividends rate) from the dividend the company pays.
How Long Do I Need to Own a Stock to Collect the Dividend?
To collect a stock’s dividend you must own the stock at least two days before the record date and hold the shares until the ex-date.
The Bottom Line
While buying stock right before the dividend date and then selling may seem like a good strategy on the surface, it's often not. Essentially, the investor would likely break even due to the decrease in stock value after the ex-dividend date. Buyers would also still have to pay taxes on the dividend.
FAQs
The Dividend Effect
Why not buy a stock before dividend and then sell? ›
If you're being serious – the dividend's simply subtracted from the price on the ex-div date, so there's no possible way to benefit from timing your buying or selling .. You're just as good selling the fund the day before the ex-div date – makes absolutely no difference. All a dividend is is self-liquidation ..
Should I buy before or after dividend? ›
The day before the ex-dividend date is the last day to buy a stock and be eligible to receive the dividend payment. The ex-date is also the day when the stock price often drops in accordance with the declared dividend amount. Traders must purchase the stock prior to this critical day.
Why sell before dividend? ›
In some ways a dividend payment is a false economy. If you wait to sell on or after the ex-dividend date, sure yes, you receive a dividend, but at the expense of the value of your shareholding. On the Ex-Dividend date, the price of a share falls by roughly the dividend amount – all other things being equal.
Should I buy stock just before the ex-dividend date? ›
If you buy a stock one day before the ex-dividend, you will get the dividend. If you buy on the ex-dividend date or any day after, you won't get the dividend. Conversely, if you want to sell a stock and still get a dividend that has been declared, you need to hang onto it until the ex-dividend day.
Why you should only buy dividend stocks? ›
Growth and Expansion of Profits
Stocks may go up or down, and there is no guarantee they increase in value. while investing in dividend-paying companies is not guaranteed to be profitable, dividend stocks offer at least a partial return on investment that is virtually guaranteed.
Can you sell stock right after dividend? ›
If shares are sold on or after the ex-dividend date, they will still receive the dividend. When you purchase shares, your name does not automatically get added to the record book—this takes about three days from the transaction date.
What is dividend stripping with an example? ›
Example of Dividend Stripping
He strategically purchases 50 shares at INR 200 each, investing a total of INR 10,000. Company XYZ declares dividends of INR 50 per share, providing Mr. A with INR 2,500 (50 * 50). After the dividend declaration, the share price drops to INR 150.
What is the dividend buying strategy? ›
This strategy is executed by buying a stock just before the ex-dividend date, so that you will be a shareholder of record on the record date, and will receive the dividend.
How do you know if a dividend is good? ›
What Is a Good Dividend Yield? Yields from 2% to 6% are generally considered to be a good dividend yield, but there are plenty of factors to consider when deciding if a stock's yield makes it a good investment. Your own investment goals should also play a big role in deciding what a good dividend yield is for you.
Dividend capture can be an effective short-term trading strategy in certain markets, but it's not a plan to gain long-term wealth. Dividend harvesting can provide steady and reliable income without worrying too much about volatile market gyrations or confusing technical analysis.
Why do stocks go down when dividends are paid? ›
The reason for the adjustment is that the amount paid out in dividends no longer belongs to the company, and this is reflected by a reduction in the company's market cap.
What are the three important dates for dividends? ›
When it comes to investing for dividends, there are three key dates that everyone should memorize. The three dates are the date of declaration, date of record, and date of payment.
Which company gives the highest dividend? ›
Overview of the Top Dividend Paying Stocks in India
- Tata Consultancy Services Ltd. ...
- HDFC Bank Ltd. ...
- ICICI Bank Ltd. ...
- Hindustan Unilever Ltd. ...
- ITC Ltd. ...
- State Bank of India. ...
- Infosys Ltd. ...
- Housing Development Finance Corporation Ltd.
This often causes the price of a stock to increase in the days leading up to its ex-dividend date. Then, when the market opens on the ex-dividend date, the security will usually drop in price by the amount of the expected dividend or distribution to be paid.
When should I own a stock to get the dividend? ›
You have to own a stock prior to the ex-dividend date in order to receive the next dividend payment. If you buy a stock on or after the ex-dividend date, you are not entitled to the next paid dividend.
Why you should not invest in dividend stocks? ›
9 In other words, dividends are not guaranteed and are subject to macroeconomic and company-specific risks. Another downside to dividend-paying stocks is that companies that pay dividends are not usually high-growth leaders.
Why do investors buy stocks that don't pay dividends? ›
Other firms have decided not to pay dividends under the principle that their reinvestment strategies will—through stock price appreciation—lead to greater returns for the investor. Thus, investors who buy stocks that do not pay dividends prefer to see these companies reinvest their earnings to fund other projects.
Should you ever sell a dividend stock? ›
Many investors will immediately sell a stock after it decides to cut its dividend, but we do our best to get out before the reduction is made. We gauge the risk of a dividend cut by analyzing a company's most important financial metrics (payout ratios, debt levels, recent earnings growth, etc.).
