Dividend capture strategy is the theory and practice of buying shares of a company before its ex-dividend date (or ex-date) in order to gain the dividend payout. The shares are then sold within a short time frame so that the process may be repeated with another stock with an upcoming dividend payment.
These dividend payments can be monthly, quarterly, annual or special (irregular).
For example, an investor buys stock in ABC Company a few days before the ex-date for its quarterly dividend and then sells it soon after. The investor then takes that money and invests it in XYZ Company three days before the ex-date of its annual dividend to capture that payment.
The investor will continue to repeat the process of buying and selling shares of various companies according to their ex-date.
Few investors utilize this strategy because of the tax implications and other pitfalls (discussed in more detail below). It can, however, be profitable with the right conditions and execution. But is it worth it when compared to other methods?
Taxes and the Dividend Capture Strategy
The IRS deems any security held for less than 61 days to be taxed as ordinary income rather than the 15% rate if held for 61 days or longer. The 60 days is counted out of a 121-day time period that begins 60 days before the ex-dividend date. This rule makes it more costly to “flip” one security for the next in order to capture the dividend.
One way to counteract the hefty tax bill is to use the dividend capture strategy using funds in a traditional or SEP IRA. Buying shares from your qualified account will defer your tax liability until your retirement years when you will most likely fall into a lower tax bracket.
A perhaps bigger issue is that share prices usually rise prior the the ex-date to factor in the dividend payment. On the day of the actual payout, the share price, at least in theory, should fall at a price that reflects the payment. If the share price falls enough, the amount received in dividends won’t be enough to make up for the loss.
The reality, though, is that the share price doesn’t always fall that much—if at all. In fact, some share prices remain steady or even increase—perhaps not exactly on the ex-date but soon thereafter. This is when the dividend capture strategy can be doubly profitable. But is it as profitable as investing in another type of dividend stock?
Capturing Larger Dividends Using Special and Annual Payouts
Obviously, the dividend capture strategy becomes much more effective if you go after larger dividend payouts and ratios. Trying to capture a dividend from a company that has a yield of, say, 3% isn’t going to be worth it. Neither is one with a lower payout ratio.
There are arguments that if you go for special or annual dividends—which are supposed to be heftier than quarterly or monthly dividends—then a capture strategy can be worth it.
The problem is that these “special” dividends aren’t always that special. Often, you can find another company paying a higher yield with a larger payout ratio.
For example, in March of 2019 Amerco (UHAL) declared a special dividend of 50 cents a share with a payout ratio of 19.82%. While this certainly would be a decent investment and not a bad strategy as far as capturing the dividend, it must be noted that same month, Verizon (VZ) paid 60.25 cents per share with a payout ratio of 49.26%.
As mentioned above, the share price doesn’t always drop to reflect the dividend payment. But it does typically ramp up in anticipation of the ex-date, providing opportunities to profit on share price alone.
Going back to your Amerco (UHAL) example, the special dividend payment was declared on March 6, 2019. The ex-date was March 21. Share prices on or around these dates were:
- March 6, 2019 (declaration date) $369.38
- March 18, 2019 (60-day high for Mar and Apr) $381.96
- March 21, 2019 (ex-dividend date): $369.56
- Marc 25, 2019 (60-day low for Mar and Apr): $357.51
- April 4, 2019 (payment date): $372.00
- Apr 24, 2019 (second highest for Mar and Apr): $378.76
In his article “Dividend Capture Strategies: This One Might Actually Work,” author Harry Domash argues that the most profit can come from purchasing the stock on the declaration date and selling the day before the ex-date.
You could consider selling even a few days before the ex-date. In our UHAL example, if you had purchased shares on the declaration date and sold them 3 days before the ex-dividend date, you would have profited $12.58 a share.
On the other hand, if you bought shares 3 days before the ex-date and sold them 4 days later, you would have suffered a loss of $24.45 on the price per share. This would have made the dividend payment of 50 cents per share not worth it.
Selling Beyond the Ex-Date
As you can see, there was another opportunity to profit on share price as well: You could have chosen to capture the dividend and wait until the share price improved in late April, thus receiving both the dividend and selling your shares at a profit.
As always, though, timing the buy and sell just right is tricky. Unless you’re somehow engaging in insider trading, you can’t ever be sure when the share price is going to recover (if at all) and for how much.
Comparing Dividend Stock Strategies
Dividend capture strategy is something to be aware of but not necessarily implemented. Like all investments, whether to buy shares to capture the dividends comes down to basic math. If the share price is good compared to recent historical prices and both the yield and payout ratios are attractive, it can be a sound investment move.
Like all investments, whether to buy shares to capture the dividends comes down to basic math.
But this strategy doesn’t escape the typical investors challenge of knowing just when to buy and sell or which security to buy next. And with the added tax implications, it can make the timing of it all that much more challenging.
You should always keep in mind that there are myriad opportunities that avoid short-term capital gains while perhaps reaping even larger profits. One could argue that buying and holding shares of a company like Verizon (VZ), with its formidable dividend yield and payout ratio, is a better strategy for growing your net worth.