DEFINITION of Dividend Selling

Dividend selling is a dishonest broker tactic that involves convincing a client to purchase a stock because it is about to pay a dividend. The broker pretends that this recommendation is in the client's best interest because the dividend will supposedly generate instant returns for the client. In reality, the trade is in the broker's best interest because of the commissions it will generate. The recommendation is dishonest because once a stock is trading ex-dividend, its price decreases approximately by the amount of the dividend, so the investor does not come out ahead.

BREAKING DOWN Dividend Selling

Dividend selling makes the investor worse off for two clear reasons. First, he has lost the commission he paid, and commissions to full-service brokers who make stock recommendations are expensive. Second, he may have a short-term tax liability because he received the dividend payment. Dividend selling by a broker may also harm the investor because he could be left with stock of a company that he knows nothing about and may be unsuitable for his investment objectives and risk profile. An honest broker would advise the client to buy the stock after the dividend had been paid to avoid the tax liability, provided that the broker recommends the purchase in the first place based on fundamentals of the company and the suitability of the security for the client.

Dividend Selling Example

Suppose a company whose stock is trading at $50 per share is about to offer a $1 dividend. A broker calls a client and tells her that she is guaranteed to pocket the $1 dividend by buying the stock before the ex-dividend date. Urged on by the broker, she buys some stock, generating commission for the broker. On ex-dividend date, the stock drops to $49 per share, erasing the illusion of the one dollar free lunch that the broker promised. On dividend payment date, when she receives the dividend, she may then incur a tax liability.