Author Topic: Why don't people just buy stock before it gives dividends, and then sell it?  (Read 7965 times)

ErikZ

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Although most stocks aren't that predictable on when they'll be giving dividends, I think I could narrow it down to the week for the big companies.

I suppose if a stock gives off 2% as a dividend, and it swings up and down more than 2%, it's a bad investment. But looking at my only dividend stock, it doesn't seem to be moving around that much around it's dividend time.

Hm. I guess I've answered my own question. Has anyone tried doing this though?

arebelspy

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This is from the last FAQ on this page, that starts with "What is "dividend capture"?"

http://www.fool.com/FoolFAQ/FoolFAQ0012.htm

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What is "dividend capture"? This is a term I heard from an investing infomercial. It sounded like a really safe and easy way to make money in the market. Is it really that good?

Dividend capture is the idea that you can buy a stock just before the dividend is paid, hold it just long enough to collect the dividend, then sell it. If you can sell it for as much as you paid for it, you have "captured" the dividend at no cost to yourself. Lovely idea, eh? But is it Foolish?

This is one of those ideas -- and not a new one by any means -- that is easier said than done. It might work with some of the lower dividend stocks, and if you have a whole bunch of money sitting around, it might even be a way to make money with little risk. But not a lot of money and not without some risk -- and a lot of work. There are easier alternatives.

The first problem is finding a stock that pays a high enough dividend, like around 8%. They are out there, but they aren't that common. The 8% is paid out quarterly, so the most you can get from any one capture is 2%, which is why you need the high dividend yield in the first place. Of course, 2% isn't bad for a short time period. But you still have to find the stock first -- and that isn't easy -- at least, it isn't easy to find before everyone else has bought into it in anticipation of the dividend, driving the price up (and your return down).

Next, you have to be able to sell the stock within a short time for at least as much as you paid for it. This is the real tricky part. The problem is that the price of a stock is reduced by the amount of the dividend paid. A few weeks before the dividend checks go out is something called "ex-dividend" day. When the exchange opens that morning, all pending orders for the stock are automatically reduced by the amount of the dividend to be paid. This is because anyone buying after that point won't actually receive the dividend -- and the payment of the dividend reduces the value of the company. (That money comes out of the company's cash balance so the company loses that amount of value when the dividends are paid.)

Now, with a company that is paying 2% annually (0.5% quarterly), that reduction might be lost in the noise level of intra-day trading and you might be able to sell the stock within a few days for the same thing you paid for it. But the higher the dividend, the less likely that becomes, or the longer it takes for the stock to rise back to that level. The time that your money is tied up is absolutely the key to using this strategy successfully.

So, let's best-case it: Say you have $10,000 to use for dividend capture and you find a stock that has declared a nice fat 8% dividend (meaning the quarterly payment will be 2%.) You buy the stock, but unless you buy immediately after the announcement, you will probably find that the price runs up a bit in anticipation of the dividend. Why? You aren't the only one who has noticed this bargain! After the ex-dividend date passes and you are assured of receiving the dividend check ($200), you place an order to sell the stock at the price you paid for it. Depending on the company and the market, that price may or may not come along for a few days or months. When it comes along, you sell the stock.

If you buy right after the dividend is announced, you will have to hold the stock for at least a month to six weeks, even if the price bounces back immediately after the ex-dividend date. If you wait to buy until just before the ex-dividend date, you risk buying at a price that anticipates the dividend, which means that when the price is reduced, it isn't as likely to come back up quickly. All of this depends on the company and the market, of course. But don't ever bet that Mr. Market is unaware of this -- when you go looking for a free lunch, it is safer to assume that Mr. Market has been there first -- and eaten all the best stuff.

You can usually find low brokerage commissions, around $8 a trade, but that is usually only for market orders and you will need to place limit orders to make this work out, which will probably cost you a minimum of around $13 per trade. So your net is $174. Now, if you can do this once a month for a year and have it work out in your favor most of the time, you can make $2,088 on your $10,000. That's 21% -- less than you would have made in an index fund during any of the last three years.

But what about during bad markets -- 21% would be great during most years, wouldn't it? Sure, it would. Reality is such a bummer, though. That 21% is possible only when the market is really roaring along. In a slow market, your money will be tied up longer and longer waiting for the price to build back up. So it works best in a hot market, but in a hot market, your returns aren't as good as an index fund. If you can't beat that no-work approach, why go to all this trouble?

You might be able to turn your money around faster by buying lower dividend stock. Some of the bigger companies pay out 2% dividends (0.5% quarterly) where the price reduction on ex-dividend day does indeed get lost in the noise. With your $10,000 you could capture $50 at a cost of $26 in commission (net $24) and only have your money tied up for maybe a week. Do that 52 times a year and... oops, that's only $1,248. Never mind. ; )

Obviously, to do this successfully, you need a pretty big cash stake. With enough cash, commissions can be virtually eliminated. But then you run into problems of actually placing a huge order without driving up the price -- and selling out without driving down the price. Darn. It's always something.

If you need another nail in this coffin, there is the fact that you pay ordinary tax income tax rates on dividend income, but if you were in an index fund, most of your gains will qualify for lower capital gains tax rates.

This is a good example of what is wrong with many heavily promoted Easy Money investing strategies. They sound good, but in reality they are simplistic and shallow. They work only in certain special circumstances that aren't that common, but unless you know a lot about them (and many successful investors don't know much about these obscure techniques because they aren't worth the time it takes to learn them well), it's easy to be fooled into thinking that they are a great deal. With 20-20 hindsight, it's easy to find examples that look good -- but much harder to create them consistently.
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vwDavid

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I reality this is harder to do. To make it worth your effort you have to do this with larger amounts at larger yields of course- and when you find a stock like that it will swing with the dividend dates nearly as much as the dividend.

I tried to capture a special dividend once and learnt the hard way. I didn't even break even. You really gotta know your dates and the stock history etc.

With a stock that doesn't swing much as you mention it might be hard enough to get the volume you need to make a 2% capture worthwhile...

shedinator

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short answer: They try.
Slightly longer answer: It's just another form of trying to time the market, and it's very statistically unlikely that anyone could succeed at it long term. It's really no different than day trading or other such approaches. Many people do it, and most fail.
Really long answer: See arebelspy's post.

jolley63

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My suggestion would be to not worry so much about selling the stock after you purchase.  You can buy before the date, capture the dividend, and just hold the stock.  You would just need to make sure you did this with companies you felt secure about.

ErikZ

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A few weeks before the dividend checks go out is something called "ex-dividend" day. When the exchange opens that morning, all pending orders for the stock are automatically reduced by the amount of the dividend to be paid.

I'm not quite following this. So, if I have an order for 100 shares at 10$ and they give off a 20 cent dividend, (2 percent), does that mean my order is being altered to 98 shares at 10$, or 100 shares at 9.80$?

If the latter, and does the stock price actually go down 2% or is it just my order?

sfb

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The price per share is reduced by the dividend amount.