Tuesday, December 2, 2008

Dividend Capture Strategy – The illusion of getting something for nothing

Dividend Capture strategies are gaining popularity among speculators who don’t want to be too exposed to market risk, while also being able to pocket the dividends. My reader Ammar Husami asked me about my opinion on the subject. The dividend capture strategy is very different in comparison to my dividend growth strategy. Before we go any further, there are four important dividend dates that investors need to understand well.

Dividend Declaration Date – This is the date on which dividends are declared by the board of directors.

Ex-Dividend Date – The Ex-dividend date is usually two days before the record date. This is the first day that the stock trades without the right to receive a dividend. On this day the price of the stock will be reduced by the amount of the dividend. The reduction comes from the price of the last trade in the previous session. If you purchase a stock on the ex-dividend date, you won’t receive a dividend until it is declared for the next time period. In order to be able to get the dividend, you will have to purchase the stock before the ex-dividend date.

Record Date - Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date.

Payment Date – This is the date on which the dividends are deposited directly in your investment account or sent in the mail.
The most important date of all is the ex-dividend date. If you purchase a stock one day before the ex-dividend date and sell it on the ex-dividend date, you will be entitled to receive the dividends.

Let’s view an example of this strategy. Below you could find a sample press release from General Electric (GE):

"August 22, 2008 9:15 AM EDT The Board of Directors of General Electric Company (NYSE: GE) authorized a regular quarterly dividend of $0.31 per outstanding share of the Company's common stock. The dividend is payable October 27, 2008 to shareowners of record at the close of business on September 22, 2008. The ex-dividend date is September 18, 2008.GE is a diversified global infrastructure, finance and media company that is built to meet essential world needs."

The declaration date is August 22, as this is when the press release went out. The record date is September 22, while the ex-dividend date is September 18. The dividend was paid on October 27, to all shareholders who owned GE stock at the close of business on September 17, 2008.

The dividend capture strategy claims that if you purchased the stock on the 17th of September and held it until the 18th; you would be eligible to receive the dividend. The problem with this strategy is that it assumes that markets are not efficient. Dividend Capture does seem appealing to investors who believe that they could get something for nothing, which in an efficient market is almost impossible as all news are immediately priced into the stock. In addition to that even if the trader does receive the dividend payment, there is no guarantee that the stock price won’t fall by more than the amount of the dividend declared.

The issue of taxes also comes to mind when determining whether to do the dividend capture or simply enjoy a simple buy and hold dividend strategy. If you simply owned GE shares and received a dividend from them every quarter, then the highest that you would get taxed at is 15%. In order for you to be eligible for the 15% tax on dividends when you do the dividend capture strategy, you have to hold the stock for at least 61 days. Furthermore, if you sell a stock after holding it for less than one year you will pay short-term capital gains taxes which could be up to 35% for the highest income brackets.

If we go back to the example with GE, the stock closed at 23.39 on Sep 17th. If you sold it on the close on Sep 18 at 24.79 you would have not only made a nice gain and be eligible to receive the dividend, but also would have avoided the volatility in the stock price.

The main issue is that traders with a short-term mindset who are trying to take advantage of the capture strategy could be exposing themselves to market fluctuations. This strategy could be profitable during bull markets as stock prices in general increase which would help the speculators in unloading their position at a profit; during bear markets when the volatility is very high, the risk of catching a big wave down is much higher.

As always, do your own research before trying any strategy that promises free lunch. In the meantime, I have selected several stocks to watch during their ex-dividend days in order to see if there’s any advantage that a dividend investor could achieve by knowing about the strategy of capturing dividends. The following stocks will be trading ex-dividend on December 3:

Bank of America, BAC, dividend amount $0.32, dividend yield 9.96%
Kimberly-Clark, KMB, dividend amount $.58, dividend yield 4.22%
Merck, MRK, dividend amount $0.38, dividend yield 6.12%
Mattel, MAT, dividend amount $0.75, dividend yield 5.96%
Pepsi Cola, PEP, dividend amount $0.425, dividend yield 3.17%
Pepsi Bottling , PBG, dividend amount $0.17, dividend yield 4.40%

Full Disclosure: I own shares of KMB, PEP, GE

Relevant Articles:

- My Dividend Growth Plan - Strategy
- Cola Wars - Coke versus Pepsi
- Analysis of General Electric
- Kimberly-Clark (KMB) Dividend Analysis

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