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? ›
If you buy stocks one day or more before their ex-dividend date, you will still get the dividend. That's when a stock is said to trade cum-dividend, or with dividend. If you buy on the ex-dividend date or later, you won't get the dividend. The ex-dividend date is in place to allow pending stock trades to settle.
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 is selling dividends a violation? ›
The selling of dividends is prohibited because the value of the dividend is factored into the price of the stock or mutual fund. This includes expected dividends, which investors consider as part of their expected returns. Selling dividends separately could involve making decisions based on nonpublic information.
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 buy a stock and sell after dividend? ›
You must have acquired your shares before the ex-dividend date in order to receive a dividend. If you acquired your shares on or after the ex-dividend date, the previous owner will receive the dividend. Sell your shares on or after the Ex-Dividend Date and you'll receive the dividend.
Should I wait for dividends before selling? ›
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 downside to dividend stocks? ›
Dividend-paying stocks have the potential for income through dividends and capital appreciation, but they come with higher volatility and market risk. The choice between the two depends on your risk tolerance, investment goals, and time horizon.
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.
How many days to hold stock for dividends? ›
Briefly, in order to be eligible for payment of stock dividends, you must buy the stock (or already own it) at least two days before the date of record and still own the shares at the close of trading one business day before the ex-date. That's one day before the ex-dividend date.
Why do stocks drop after ex-dividend date? ›
Why Does the Stock Price Fall on the Ex-Dividend Date? The price of a stock tends to fall by the amount of the dividend on its ex-dividend date, reflecting that its assets will soon be dropping by the amount of the dividend.
What is the 3 day rule in stocks? ›
The 3-Day Rule in stock trading refers to the settlement rule that requires the finalization of a transaction within three business days after the trade date. This rule impacts how payments and orders are processed, requiring traders to have funds or credit in their accounts to cover purchases by the settlement date.
How much dividend income is tax free? ›
For single filers, if your 2023 taxable income was $44,625 or less, or $89,250 or less for married couples filing jointly, then you won't owe any income tax on dividends earned.
What is an illegal dividend? ›
Unlawful dividends are where money is extracted from a limited company when there are insufficient profits to allow for this. Shareholders in receipt of an unlawful dividend may be asked to repay this money to the company if they were aware the company could not afford to make this distribution.
Can I sell before dividend payout? ›
The ex-dividend date is set the first business day after the stock dividend is paid (and is also after the record date). If you sell your stock before the ex-dividend date, you also are selling away your right to the stock 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.).
