Dividend Capture Strategy: How It Works

In stock trading, a dividend refers to a distribution of cash or stock to shareholders in a company. In many cases, this money is withdrawn from a company’s retained earnings. In other words, dividends are payments made to you because you’re a shareholder.

Investors have the option to buy and hold stocks that pay dividends, making them an excellent option for earning passive income and getting the most out of your stock market knowledge.

However, like with all investment strategies, there’s always some inherent risk involved. One popular strategy that investors use is known as the dividend capture strategy. This is also referred to as buying the dividend and can be a risky choice due to tax considerations, but it’s also a solid investment to make if you’re confident about the stock.

How Dividends Work

As mentioned in the introduction, dividends are essentially payments that firms make to their shareholders. Most people choose for these dividends to be paid in cash, but there’s also the option to receive shares of a stock. So any time the company makes money, you’re essentially entitled to a portion of it, meaning it’s in your interest to see the company succeed.

But while these payments can be withdrawn at any time, they are typically made every quarter. This is known as a dividend date. This means that if you invest in a company that is close to its dividend dates, you’ll receive your share of their earnings much sooner than expected. This is what forms the basis of a dividend capture strategy.

How Dividend Dates Work

There are four things to remember when it comes to dividend dates:

• Declaration date refers to the date that the board of directors announces a dividend payment. This date occurs well in advance of the payment itself.
• The ex-dividend date is the first date that new stock buyers won’t receive their dividends. Since stocks take around three days to settle once a trade is made, this date is often two trading days before the record. If you owned stock before the ex-dividend date, then you’ll receive your expected payment. However, if you invest too late, you won’t receive your dividends for that quarter. This also means that people can sell their shares on the same day that the ex-dividend date is announced. You’ll receive both your dividends from the company and also money from the sale of your stocks since they are processed around three days after your decision is made.
• Date of record or in-dividend date refers to the date at which new buyers of a share won’t qualify for pending dividend payments. This date is more of a formality, and it’s important to consider the ex-dividend date instead. To investors, this date is important because if you sell shares before the record date, you won’t receive your dividend payments for that quarter.
• The pay date is the date on which the payments will be made. They can be deposited into an account you have arranged with the company or shareholder account. Alternatively, you can get a check.

Buying the Dividend

As briefly mentioned earlier, one strategy that investors use is to “buy the dividend.” This involves trying to time their purchase of dividend stocks or mutual funds to closely align with the ex-dividend date of a company.

Once they have secured their dividend payment, they can choose to keep it if they wish, but it’s more common to sell the shares shortly after a buy and continue to look for more opportunities. This is known as a dividend capture strategy. Unfortunately, this strategy is harder to pull off than it seems.

Another option is to buy and sell options that could profit from the fall of a stock price when the dividend is paid out. This is a much more complicated strategy that experienced investors use to take advantage of both small and large yields that are frequently compounded.

What Makes a Dividend Capture Plan Risky?

There are a number of things that can make a dividend capture plan a potentially risky choice:

• Markets can be pretty efficient, meaning that stock prices can potentially increase because other people are also expecting certain companies to make their dividend payouts soon.
• It takes a lot of research to choose a target when attempting to buy the dividend. It’s risky to assume you know the stock's ex-dividend date, and most of the information is only given to existing investors. This means you’ll need to have a strong network of investors willing to share the information with you.
• It’s not favorable when it comes to tax implications. This is because dividends collected with a dividend capture strategy don’t get considered as qualified dividends. That means you’ll be paying more income tax on those earnings. In order to pay less tax on dividends, you’ll need to have held that stock for at least 60 days during the 121-day period that starts 60 days before the ex-dividend date.
• Lastly, there are transaction costs that you need to consider as well. This further decreases the amount you can make with this strategy. In order to cover these brokerage fees, you’ll need to purchase a larger position.

In Conclusion

A dividend capture strategy is a great idea for an alternative form of investment, especially if you’re playing with the idea of short-term gains. If you have contacts with insider knowledge, then it can be fairly easy to profit off these strategies, especially if you have a considerable amount of money to invest in the first place. 

However, it may be more convenient for people to simply stick with the purchased stock and watch it grow over a longer period. This usually offers more consistent gains reduced transaction costs and often ends up becoming the better long-term strategy if you’re not accustomed to trading.

If you are confident in your trading ability, though, and can stay on top of market fluctuations and industry insights, then you can certainly make quick gains. Just remember that there are additional fees and considerations to keep in mind if you want to make the most of it.