What Is Dividend Selling?
Dividend selling refers to a dishonest sales tactic used by some unethical brokerage firms. It consists of recommending the purchase of a dividend-paying company to a client, shortly before the payment date of that dividend.
This sales pitch, which would typically be made to financially unsophisticated clients, involves conveying the impression that the dividend payment constitutes a form of free income for the client. In reality, this impression is highly misleading because the market price of dividend-paying shares generally decreases by an amount equal to the dividend payment shortly following the payment date.
From the broker’s perspective, such transactions can be an easy way to repeatedly generate commission revenue—despite the fact that they are not in the client’s best interest. Accordingly, dividend selling is frowned upon by those in the investment management industry.
- Dividend selling is an unethical sales tactic used by some brokers.
- Dividend selling involves encouraging a client to invest in a dividend-paying company under false pretenses, usually to generate commission revenue for the broker.
- Elderly investors who rely on their portfolios for retirement income may be especially vulnerable to this practice.
How Dividend Selling Works
Dividend selling is a dishonest sales tactic that involves convincing a client to purchase a stock on the grounds that it will soon pay a dividend. When communicating with the client, the broker leads them to believe that such a purchase would be in their best interest because of the supposedly free income that the dividend would provide. In practice, however, this is simply false.
Generally speaking, financial markets are very efficient at re-pricing the shares of dividend-paying companies once their dividend has been paid. Because the price of a stock is generally viewed as reflecting the present value of its future cashflows, it makes sense for investors to discount its shares once one of those future cashflows—the dividend in question—has already been paid to investors.
Although most investors will be familiar with this fact, and would therefore not be persuaded by the dividend selling sales pitch, this may not be true for relatively unsophisticated investors who are relying on their brokers as investment advisors. The risk may be particularly pronounced for elderly investors who are relying on their stock portfolios for retirement income. For such investors, the promise of a free dividend could be especially enticing, making them vulnerable to exploitation from unscrupulous brokers. To make matters worse, the dividend income could generate a tax liability, further harming the investor in question.
Example of Dividend Selling
Emma is a retiree who has invested her retirement savings into a stock portfolio. In managing her portfolio, she is highly reliant on the advice of her broker.
One day, Emma’s broker contacts her to recommend that she purchase shares in XYZ Corporation—a company currently trading at $50 per share and which is about to pay out a $1 dividend to its shareholders.
Emma’s broker tells her that, if she acts quickly, she can receive the $1 dividend and then simply sell the shares to recuperate her investment. That way, she can obtain additional income to fund her retirement, without any risk to her retirement savings. Grateful for the timely advice, Emma consents to the transaction.
On the ex-dividend date, XYZ’s stock declines to $49 per share, as investors adjust their valuation of the company to reflect the fact that its future income stream has declined by $1 per share. This was a predictable occurrence, which any informed investor would have anticipated. Unfortunately for Emma, she was the victim of an unethical broker who exploited her trust and lack of knowledge.