What Is Dividend Capture?

Dividend capture is a timing-oriented investment strategy focused on buying and selling dividend-paying stocks. The strategy involves buying a stock just before its ex-dividend date to capture the dividend, then selling it on or after the ex-dividend date. The purpose of the strategy is to receive the dividend, as opposed to selling the stock at a profit.

Key Takeaways

  • Dividend capture is a strategy where a stock is bought before the ex-dividend date to capture the dividend and then sold on or after the ex-dividend date.
  • Theoretically, a stock should drop by the dividend amount on the ex-dividend date, but this doesn't always happen.
  • Because the dividend isn't the only factor in the stock price, traders can capture net profits if the price of the stock drops less than the dividend amount received.

Understanding Dividend Capture

A dividend capture strategy takes advantage of regular cash infusions from dividends. The downside is that on the ex-dividend date, the stock should drop by the dividend amount since that capital has now been allocated to shareholders and is no longer part of the value of the company.

This doesn't always play out. For example, assume a $50 stock—at the close before the ex-dividend date—pays a $1 dividend. On the ex-dividend date, the stock should open at $49. Yet the dividend isn't the only factor in a stock price.

In a rising market, buyers may be eager to purchase the stock, so it opens the next morning at $49.75 or even $50.20. In either case, the dividend capture investor can sell the stock and still make a net profit. They receive $1 per share in dividends and only take a $0.50 loss (at $49.50) on the stock. If the stock were to open at $50.20, possibly because the broader market is up significantly, the trader nets $1.20 per share.

The price of the stock could also open lower than expected, at $48 for example. In this case, the trader has a net loss of $1 per share ($48 - $50 + $1). There are risks. The dividend amount is fixed, yet the potential loss amount is not.

Special Considerations

Stocks under heavy accumulation are less likely to see a reduction in stock price on the ex-dividend date. A stock in a strong uptrend is also more likely to appreciate, potentially resulting in a dividend plus a profit on the stock sale.

The flip side is that stocks in downtrends may fall more than expected on the ex-dividend date and after. As a result, a trader may opt to exit the stock at a more profitable time, instead of on the ex-dividend date. For example, an investor may hold the stock for a few days, waiting for a better selling opportunity. The downside of this is the share price could continue to fall.

A dividend capture strategy is generally used on stocks that pay a sizable dividend, to make the strategy worthwhile. It is also typically used on stocks with high trading volume.

Criticism of Dividend Capture

Under most circumstances, the dividend capture strategy doesn't produce a tax advantage. The dividend returns are taxed at the investor's ordinary tax rate. This is because the trade is not held long enough to benefit from the favorable tax treatment on dividends that a longer-term investor would receive. However, the tax treatment of the strategy is not an issue if the strategy is employed in a tax-advantaged account, such as an individual retirement account (IRA).

Transaction costs also need to be accounted for. With various major companies paying dividends almost every day, this could be a very active strategy. The more active the strategy, the more trading commissions that will be paid. However, with some brokers moving to a no-commission trading model, the odds of successfully using certain active strategies increases.

Example of Dividend Capture

On Feb. 19, 2020, Microsoft (MSFT) went ex-dividend after declaring a $0.51 dividend. The stock closed at $187.23 the day before the ex-dividend date. Shares could have been purchased at this price or below. Holding shares before the ex-dividend date entitles the trader to the $0.51 dividend.

The following day the stock opened at $188.06. The trader could immediately sell, locking in a $0.83 profit on the shares, on top of the $0.51 dividend. It is worth noting that MSFT was in a strong uptrend at the time.

On the same day, Delta Air Lines (DAL) went ex-dividend. They had declared a $0.4025 dividend. The stock closed the prior day at $58.72. The next morning, the ex-dividend day, the stock opened at $58.49. The trader could sell at this price for a $0.23 loss on the shares, but also receive the dividend of $0.4025, for a net profit of $0.1725 per share. The stock was in a choppy and trendless period at this time.