A Dividend Primer, You Don't Get Something for Nothing

Dividend Capture strategies are gaining popularity among speculators who don’t want to be too exposed to market risk, while also being able to pocket the dividends. My reader Ammar Husami asked me about my opinion on the subject. The dividend capture strategy is very different in comparison to my dividend growth strategy. Before we go any further, there are four important dividend dates that investors need to understand well.

Dividend Declaration Date – This is the date on which dividends are declared by the board of directors.

Ex-Dividend Date – The Ex-dividend date is usually two days before the record date. This is the first day that the stock trades without the right to receive a dividend. On this day the price of the stock will be reduced by the amount of the dividend. The reduction comes from the price of the last trade in the previous session. If you purchase a stock on the ex-dividend date, you won’t receive a dividend until it is declared for the next time period. In order to be able to get the dividend, you will have to purchase the stock before the ex-dividend date.

Record Date - Shareholders who are not registered as of this date will not receive the dividend. Registration in most countries is essentially automatic for shares purchased before the ex-dividend date.

Payment Date – This is the date on which the dividends are deposited directly in your investment account or sent in the mail.

The most important date of all is the ex-dividend date. If you purchase a stock one day before the ex-dividend date and sell it on the ex-dividend date, you will be entitled to receive the dividends.

Let’s view an example of this strategy. Below you could find a sample press release from General Electric (GE):

August 22, 2008 9:15 AM EDT The Board of Directors of General Electric Company (NYSE: GE) authorized a regular quarterly dividend of $0.31 per outstanding share of the Company's common stock. The dividend is payable October 27, 2008 to shareowners of record at the close of business on September 22, 2008. The ex-dividend date is September 18, 2008.GE is a diversified global infrastructure, finance and media company that is built to meet essential world needs.

The declaration date is August 22, as this is when the press release went out. The record date is September 22, while the ex-dividend date is September 18. The dividend was paid on October 27, to all shareholders who owned GE stock at the close of business on September 17, 2008.

The dividend capture strategy claims that if you purchased the stock on the 17th of September and held it until the 18th; you would be eligible to receive the dividend. The problem with this strategy is that it assumes that markets are not efficient. Dividend Capture does seem appealing to investors who believe that they could get something for nothing, which in an efficient market is almost impossible as all news are immediately priced into the stock. In addition to that even if the trader does receive the dividend payment, there is no guarantee that the stock price won’t fall by more than the amount of the dividend declared.

The issue of taxes also comes to mind when determining whether to do the dividend capture or simply enjoy a simple buy and hold dividend strategy. If you simply owned GE shares and received a dividend from them every quarter, then the highest that you would get taxed at is 15%. In order for you to be eligible for the 15% tax on dividends when you do the dividend capture strategy, you have to hold the stock for at least 61 days. Furthermore, if you sell a stock after holding it for less than one year you will pay short-term capital gains taxes which could be up to 35% for the highest income brackets.

If we go back to the example with GE, the stock closed at 23.39 on Sep 17th. If you sold it on the close on Sep 18 at 24.79 you would have not only made a nice gain and be eligible to receive the dividend, but also would have avoided the volatility in the stock price.

The main issue is that traders with a short-term mindset who are trying to take advantage of the capture strategy could be exposing themselves to market fluctuations. This strategy could be profitable during bull markets as stock prices in general increase which would help the speculators in unloading their position at a profit; during bear markets when the volatility is very high, the risk of catching a big wave down is much higher.

As always, do your own research before trying any strategy that promises free lunch. In the meantime, I have selected several stocks to watch during their ex-dividend days in order to see if there’s any advantage that a dividend investor could achieve by knowing about the strategy of capturing dividends. The following stocks will be trading ex-dividend on December 3:

Bank of America (BAC), dividend amount $0.32, dividend yield 9.96%
Kimberly-Clark (KMB), dividend amount $.58, dividend yield 4.22%
Merck (MRK), dividend amount $0.38, dividend yield 6.12%
Mattel (MAT), dividend amount $0.75, dividend yield 5.96%
Pepsi Cola (PEP), dividend amount $0.425, dividend yield 3.17%
Pepsi Bottling (PBG), dividend amount $0.17, dividend yield 4.40%

Disclosure: Auhtor owns shares of KMB, PEP, GE.

Comments

[22thoroughbred:]

I have NEVER been a fan of dividends, why give me back my own money and make it a taxable event (in a taxable acct. of course) I buy 1000 shares of company A at $10 (spending $10,000) they pay a $1 per share dividend and thus reduce the stock price by $1, so now I still have $10,000 worth of assets, but it is $9,000 stock $1,000 in dividend = $10,000 and I have to pay tax on the $1,000 dividend. Too many novice investors don't realize the stock is reduced by the amount of the div. and that's with penny pricing now, it used to be if a co. paid an 8 cent div. the stock was reduced by 1/8th or 12.5 cents, so you would lose money. It was rounded UP to the nearest 1/8th and reduced, so in a year in that scenerio you receive back 32 cents ( 8 cents x 4 divs.) and the stock was reduced by 50 cents (12.5 cents x 4 divs.) No Thanks...

2008 Dec 02 04:15 PM

[Dividend Gr...:]

22Thoroughbread,

You are looking at the issue from the standpoint of a daytrader. It is true that the stock price at the open is reduced by the amount of the dividend, but more often than not this is only a cosmetic change as the market adjusts it value up or down based off other factors.
Stocks that pay dividends tend to outperform those that do not, as their dividend checks tend to soften any declines in bear markets and further compound your profits in bull markets.

2008 Dec 02 05:32 PM

[tradeorfade:]

Wow! That has to be the dumbest comment I have read on a financial blog...EVER.

2008 Dec 02 09:46 PM

[YoYoMama:]

You are forgetting that many of us hold dividends in an IRA or 401(k) account, in which case the dividends are not taxable if funds are not withdrawn.

There isn't just ONE right way to invest, that being YOUR way. Some of us aren't daytraders like you, but are instead investing towards retirement. Don't worry, whippersnapper, you'll be there someday, in which case, Dividend Growth Investor will start looking like a real genuis.


On Dec 02 09:46 PM 22Thoroughbreadisanidi... wrote:

> Wow! That has to be the dumbest comment I have read on a financial
> blog...EVER.

2008 Dec 03 08:30 AM

[sumosama:]

I think you are confusing NAV and mutual funds with regards to dropping the price. Stock prices are determined by the market and nothing more.

2008 Dec 03 10:17 AM

[Boubou:]

The analysis below is correct but it ignores the fact that during the years when the company retains your money and distributes nothing, what do they do with it? Do they compensate themselves lavishly?, do the do acquisitions which turn out badly?, Does the value of the retained income collapse due to factors external?, .all of the above?


On Dec 02 04:15 PM 22thoroughbred wrote:

> I have NEVER been a fan of dividends, why give me back my own money
> and make it a taxable event (in a taxable acct. of c analysourse) I buy
> 1000 shares of company A at $10 (spending $10,000) they pay a $1
> per share dividend and thus reduce the stock price by $1, so now
> I still have $10,000 worth of assets, but it is $9,000 stock $1,000
> in dividend = $10,000 and I have to pay tax on the $1,000 dividend.
> Too many novice investors don't realize the stock is reduced by the
> amount of the div. and that's with penny pricing now, it used to
> be if a co. paid an 8 cent div. the stock was reduced by 1/8th or
> 12.5 cents, so you would lose money. It was rounded UP to the nearest
> 1/8th and reduced, so in a year in that scenerio you receive back
> 32 cents ( 8 cents x 4 divs.) and the stock was reduced by 50 cents
> (12.5 cents x 4 divs.) No Thanks...

2008 Dec 03 10:23 AM

[Dividend Gr...:]

You are not discrediting me with your childish comments. You are discrediting yourself with your 6 posts on SeekingAlpha. Shame on you.


On Dec 02 09:46 PM 22Thoroughbreadisanidi... wrote:

> Wow! That has to be the dumbest comment I have read on a financial
> blog...EVER.

2008 Dec 03 10:46 AM

[Augustus:]

For the pro or con dividend argument look at DELL.
Profits pretty consistently. No dividend. Little Book Value. Where did the money go? Would they have operated the company differently if required to supply some money to the stockholders?

2008 Dec 03 11:19 AM

[David Van K...:]

Thorobred's analysis is not correct. He makes it sound like each dividend payment is automatically subtracted from the stock's price. That is not the way it works.

As sumosama said, the stock's price is determined by the market. When a company announces a dividend increase, sometimes its share price goes up, as market participants interpret that as good news for the future, believing that management would not increase the dividend if they did not have clear visibility of rising profits ahead.

Dividend Growth Investor is correct that many studies show dividend stocks have the largest total return over long time periods. Dividends are the most transparent thing a company can do with its profits. Many shareholders invest in dividend-paying stocks precisely because they pay dividends.

Every company has to decide what to do with its profits: retain them, use them to buy its own shares, make acquisitions, fund internal projects, etc. The list is endless. Many companies do not need to retain all their earnings in order to grow at a healthy and sustainable rate. Therefore, such companies pay out some of those profits as dividends. This is a benefit to their shareholders and the best possible use of that cash.

2008 Dec 03 03:33 PM

[22thoroughbred:]

Sumosama and David, I am sorry but you are incorrect, a stock price is adjusted DOWN on the opening on Ex-Dividend date by the exact amount of the dividend. If it closed the night before at $10 and pays a 50 cent div. the bid price is $9.50...now you are correct, orders to buy and sell pre-open or news pre-open does effect the price as usual, but it is derived from the $9.50 price initially. That I am 100% correct. And yOYO in the 2nd line of my post I specifically state this is relevant to taxable accounts, and that is the basis for my opinion...I don't want to report my own money as taxable dividend income, even at 15%...

2008 Dec 05 12:08 PM