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 ..
Is it good to buy stock before a dividend? ›
It represents the date on which a stock begins trading without the value of its upcoming dividend payment. Investors who purchase the stock before the ex-dividend date are entitled to receive the dividend, while those who buy on or after the ex-date will not receive the payout.
Is it better to buy before or after the ex-dividend date? ›
The stock price drops by the amount of the dividend on the ex-dividend date. Remember, the ex-dividend date is the day before the record date. If investors want to receive a stock's dividend, they have to buy shares of stock before the ex-dividend date.
Why sell before dividend? ›
It's a question we're frequently asked. The short answer for most people is “no”. In the short term, receiving a dividend comes at the expense of the capital value of your shareholding; shares fall by roughly the dividend amount on the Ex-Dividend Date (if you ignored all other market forces).
Why you should only buy dividend stocks? ›
Five of the primary reasons why dividends matter for investors include the fact they substantially increase stock investing profits, provide an extra metric for fundamental analysis, reduce overall portfolio risk, offer tax advantages, and help to preserve the purchasing power of capital.
Can you sell stock right after dividend? ›
Another important note to consider: as long as you purchase a stock prior to the ex-dividend date, you can then sell the stock any time on or after the ex-dividend date and still receive the dividend. A common misconception is that investors need to hold the stock through the record date or pay date.
How many days before should I buy share to get dividend? ›
The ex-dividend date is the first day the stock trades without its dividend, thus ex-dividend. If you want to get the dividend payment, you need to own the stock by this day. That means you have to buy before the end of the day before the ex-dividend date to get the next dividend. In other words, it's the cut-off date.
What is the dividend chasing 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.
What is the downside to dividend stocks? ›
Despite their storied histories, they cut their dividends. 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.
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 do stocks drop after a dividend? ›
It's no different for a company. Money that a company pays to shareholders is money that is no longer part of the asset base of the corporation. This money can no longer be used to reinvest and grow the company. That reduction in the company's "wealth" has to be reflected in a downward adjustment in the stock price.
What happens if you buy after ex-dividend date? ›
Investors who purchase a stock on its ex-dividend date or after will not receive the next dividend payment. Instead, the seller gets the dividend. Investors only get dividends if they buy the stock before the ex-dividend date.
Why not buy a stock right before dividend? ›
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.
What happens if you buy a stock after hours the day before the ex-dividend date? ›
The ex-dividend date for stocks is usually set one business day before the record date. If you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend. If you purchase before the ex-dividend date, you get the dividend.
When should you sell dividends? ›
Sell the shares as soon as the market opens on the ex dividend date. This way, you can minimize the price fall to a certain extent and still get to enjoy a part of the dividend payout. Wait for the share price to bounce back up.
Why you should not invest in dividend stocks? ›
“One mistake to avoid,” Cabacungan says, “is to buy a company's stock simply because it issues a high dividend.” If the company has leveraged excessive debt to fund the dividend, it could come at the expense of future profitability and hurt growth prospects.
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.
Does chasing dividends work? ›
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.
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.).
