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Dennis Benfante, Allentown, PA, wrote:
Like the Capistrano swallows, this question shows up in my mailbox within hours every time I talk about dividends. Thanks, Dennis, for confirming my faith in the universe.
This question always makes me smile because I, too, explored the "dividend capture" strategy when I first heard of it. It sounds like such a cool idea! One thing I learned is that cool ideas have usually been thought of before and, if they were successful, something has always come along to ruin them.
In the case of dividend capture, I'm not sure it has ever been successful in any kind of sustainable way. The theory is that you only need to hold a stock for a few days to "capture" the dividend, so you buy the stock, hold it just long enough to become a holder-of-record, then sell it and buy another high-dividend stock.
The fly in the ointment here is... well, I guess you would have to call it "fairness." When a company pays out dividends, the actual fair market value of that company is reduced by the value of all that cash that just went out the door, right? Just like when you blow a hundred bucks on a night on the town. You haven't reinvested that money, you have nothing to show for it but hopefully some good memories, and your net worth goes down.
In the interest of fairness, the stock exchanges compensate for this drop in the net worth of a company each time a dividend is paid. Before the opening bell, the prices on all pending orders for a stock that is going ex-dividend are reduced by the amount of the dividend. So if a stock pays a $0.50 dividend, any one who has placed a limit order to buy a stock at, say $50.00, would have their limit order reduced to $49.50. In effect, on ex-dividend day the price of the stock is lowered by the amount of the dividend paid.
So you buy the stock with the dividend attached, but when you go to try and sell it, the market has reduced the price by the amount of the dividend.
Now, this can be difficult to see because it's not at all unusual for stock prices to fluctuate this much from one day to the next just in the course of normal business. But that doesn't mean that the effect isn't there. Investors aren't generally willing to pay $50.00 for a stock that just reduced its net worth by $0.50 per share, all other things being equal.
The larger the dividend, the more pronounced and long-lasting the price drop. What this means for those trying to use the dividend capture strategy is that they will find that on average, the companies they invest in won't rise to their pre-dividend price for several weeks or months. Now, of course, if a company is growing nicely and the market is up, you may be able to run a dividend capture strategy successfully for a while. At least it may look successful.
That's where commissions, spread, and taxes come in. Every transaction has a cost, even though they are lower now than ever. By the time you pay your commission, lose your two bits to the spread, and pay regular income taxes on the dividends you captured (no capital gains tax break for this deal), there is very little left over, even when the market is good. And this strategy takes a LOT of time to run. (I know, I tried it.)
It's really annoying how these exercises keep coming back to the same darn thing every time. Do your homework, buy and hold, follow the strategy. Just once, I'd love to find a better way!
Fool on and prosper!
What do you think of this strategy: hunt high-yield dividend stocks and purchase them [just before] the ex-dividend date. Then immediately sell them and place the cash in another high-yield stock. Eventually you could get on a good rotation of steady stocks with good yields. Of course there are the tax implications and the broker fees. Do you think this is a safe way of getting a good return?