Undeniably, access to trading the world’s markets has never been easier to the average retail investor than it is today.
This has in turn boosted the popularity of investment strategies which claim to relax the rules of the long-standing financial relationship between risk and reward, by letting investors enjoy more of the latter without assuming much of the former.
One such example is the dividend capture strategy. Before we examine whether this is even possible, we need to look at the dividend payment schedule and highlight the four important dates of the process.
The dividend payment scheduleThere are four key dates associated with any dividend payment. First, there’s the declaration date; as the name suggests, this is the day when the company’s board of directors announce the amount and the date the dividend will get paid.
Then, there’s the ex-dividend date, also known as the dividend detachment date; in order to be entitled to receive the dividend, an investor must hold the stock on the day prior to the ex-date.
After that comes the record date; on this day, the company checks its records to determine which shareholders are eligible to receive the dividend. And finally, there’s the pay date; the day on which the dividend is actually paid to eligible shareholders.
What is the dividend capture strategyThe dividend capture strategy is an investment tactic stemming from the fact that investors are entitled to receive a dividend from a company, even if they only hold its stock for a single day, the one before the ex-date.
The strategy aims to exploit an alleged difference between theory and practice in stock price movements around that day, and then simply repeat the process with another stock.
How it worksAn investor who buys a stock on the ex-dividend isn’t eligible to receive that dividend. Had he bought it a day earlier, he would have been.
Financial theory therefore suggests that on the ex-dividend date, the stock price should decrease accordingly by the amount of the dividend, because the stock no longer carries with it that implicit dividend value.
Advocates of the dividend capture strategy suggest this isn’t what happens in practice, but instead, the stock often recovers within a short timeframe to the level it was trading at before the dividend detachment.
An investor employing this strategy could simply sell the stock when that happens, essentially pocketing the dividend, and then repeat the process with the next stock in the dividend calendar.
In effect, the investor could be redeploying the same capital over and over again, thus achieving superior annual investment returns. At the extreme, with a great number of dividend-paying stocks in the market, an investor could practically utilise this strategy on a daily basis.
Shortcomings of the strategyThe tactic might sound simple enough, certainly compared to other, more technical investment strategies, but in practice there are plenty complications in its execution.
First and foremost, there is clearly no guarantee that the stock will recover to the level it was trading prior to its ex-date in a short timeframe, if at all.
On the contrary, the ex-date price drop could easily exceed the amount of the dividend, particularly in the case of bad news or an investment climate turning sour.
Claims made by proponents of this strategy that stocks often recover the ex-dividend drop may be losing track of the fact that the market is currently going through a multi-year bull market.
An argument can also be made about the optimal timing for entering this strategy. As easy as the proposition of buying the stock on the day before the ex-date might seem, with so many investors focused on dividend income, the increased demand for the stock will likely have already been reflected on its price.
Finally, any strategy involving short holding periods and thus frequent trading is bound to be weighed down by increased transaction costs, which might substantially reduce profits.
All in all, the dividend capture strategy sounds attractive in theory, but poses complications in practice, and it’s certainly not without risk. As always, investors are advised to consult with their financial advisor first.
