Dividend Capture: Meaning, Criticism, Examples

What Is Dividend Capture?

The term dividend capture refers to an investment strategy that focuses on buying and selling dividend-paying stocks. It is a timing-oriented strategy used by an investor who buys a stock just before its ex-dividend or reinvestment date to capture the dividend. The investor then sells it on or after the ex-dividend date at or above the purchase price. The purpose of the strategy is to receive the dividend, as opposed to just selling the stock at a profit.

Understanding Dividend Capture

A dividend capture strategy is generally used on stocks that pay a sizable dividend to make the strategy worthwhile. It is also used on stocks with high trading volume. This strategy takes advantage of regular cash infusions that result from dividends.

There is no one-size-fits-all approach to this strategy. As mentioned above, some investors purchase shares in dividend-paying stocks just before the ex-dividend date and sell it on that date. Others may choose to hold onto their shares for a day or two before selling them.

The purpose of this strategy is to make a profit by selling the stock at or above the amount of purchase. This can also happen if the stock's price drops down by less than the amount of the dividend since that capital is allocated to shareholders and is no longer part of the value of the company.

But this doesn't always play out that way because share prices don't necessarily drop by just the price of the dividend. There are a number of factors that shape a company's share price. And the dividend is just one thing that can affect the price. Demand can also weigh in on share prices.

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 and after the ex-dividend date. 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 wait for a better selling opportunity by holding the stock for a few extra days. The downside of this is the share price could continue to fall.

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. That's 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 by investors. 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 are 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

Let's assume a $50 stock pays investors a $1 dividend. The stock should open at $49 on the ex-dividend date. In a rising market, it opens the next morning at $49.75 or even $50.20. In either case, the dividend capture investor can sell the stock and 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.

But there are risks. The price of the stock could also open lower than expected, say at $48. In this case, the trader ends up with a net loss of $1 per share ($48 - $50 + $1). The dividend amount is fixed, but the potential loss amount is not.

Real-World Example of Dividend Capture

Microsoft

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 their holdings, 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.

Delta Air Lines

On the same day, Delta Air Lines (DAL) went ex-dividend. The company declared a $0.4025 dividend per share. 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, though, was in a choppy and trendless period at this time.