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I've read many articles and comments that refer to the notion of dividend capture, i.e., purchasing a stock right before the ex-dividend date in order to qualify for that dividend. First, for a taxable account, this is highly tax inefficient investing. You've essentially transformed a portion of your balance sheet cash into taxable income. Most people seek investments that minimize tax burdens, not investments that increase taxes paid.

The second aspect is that there is no true economic value creation. At first glance, some people might say great, I get this dividend for owning the stock for just a day, it is effectively free. The cash for the dividend is already valued in the stock price that you've purchased. The value of the stock will drop by an amount equivalent to the dividend after the dividend is committed at the opening of the ex-dividend date. The stock price is effectively reduced by the dividend amount paid to the shareholder. There is no magical value creation.

In the taxable account, the taxable income created is effectively offset by capital loss in the future (assuming that there are no other impacts on the stock, which is very unlikely). So most likely in the near term you will pay more taxes with a potential tax benefit in the future. In tax deferred accounts, the tax impact is obviously not a factor. Furthermore the status of qualified dividends precludes the possibility of a tax rate arbitrage. A qualified dividend is taxed at 15%, at least under the George W. Bush tax policies, while losses can be potentially used to offset against ordinary income. Due to differences in these rates, one might see an arbitrage. However, in order for a dividend to be qualified, the investor has to own the stock for a window of 60 days around the ex-dividend date. Over this time frame, one would be taking sufficient risk in owning the stock that would probably offset any potential tax benefit not to mention to the exposure to the stock itself.

To take a closer look at opening stock prices on the ex-dividend date, I chose a popular dividend stock, Frontier Communications (NASDAQ:FTR). FTR is currently offering a sky high dividend yield of 15.0% based on a forward dividend of $0.75 and the recent closing price of $4.99. Before you get too excited though, it should be noted that FTR is also down almost 50% from a year ago. I looked the difference between the closing price on the day before ex-dividend and opening price on the ex-dividend date for every dividend back to 2005. There was never a case when the stock opened the next day at a higher price than the previous day's close as one would expect.

FTR Price Changes
Ex-dividend date Previous trading day Dividend amount Previous trading day closing price Ex-dividend date open Decrease
12/7/2011 12/6/2011 0.1875 5.78 5.5 $0.28
9/7/2011 9/6/2011 0.1875 7.19 7.06 $0.13
6/7/2011 6/6/2011 0.1875 8.37 8.16 $0.21
3/7/2011 3/4/2011 0.1875 8.13 8.01 $0.12
12/7/2010 12/6/2010 0.1875 9.47 9.34 $0.13
9/7/2010 9/3/2010 0.1875 7.94 7.78 $0.16
6/7/2010 6/4/2010 0.2500 8.34 8.15 $0.19
3/5/2010 3/4/2010 0.2500 7.61 7.43 $0.18
12/7/2009 12/4/2009 0.2500 8.46 8.1 $0.36
9/4/2009 9/3/2009 0.2500 7.19 7.02 $0.17
6/5/2009 6/4/2009 0.2500 7.54 7.36 $0.18
3/5/2009 3/4/2009 0.2500 6.86 6.57 $0.29
12/5/2008 12/4/2008 0.2500 8.15 8.08 $0.07
9/5/2008 9/4/2008 0.2500 12.54 12.29 $0.25
6/5/2008 6/4/2008 0.2500 11.56 11.49 $0.07
3/6/2008 3/5/2008 0.2500 11.13 11.05 $0.08
12/5/2007 12/4/2007 0.2500 12.81 12.81 $0.00
9/5/2007 9/4/2007 0.2500 14.64 14.21 $0.43
6/6/2007 6/5/2007 0.2500 15.7 15.51 $0.19
3/7/2007 3/6/2007 0.2500 14.81 14.6 $0.21
12/6/2006 12/5/2006 0.2500 14.29 14.17 $0.12
9/6/2006 9/5/2006 0.2500 13.8 13.52 $0.28
6/7/2006 6/6/2006 0.2500 12.76 12.61 $0.15
3/7/2006 3/6/2006 0.2500 13.62 13.32 $0.30
12/7/2005 12/6/2005 0.2500 12.61 12.38 $0.23
9/7/2005 9/6/2005 0.2500 13.78 13.5 $0.28
6/7/2005 6/6/2005 0.2500 13.44 13.38 $0.06
3/16/2005 3/15/2005 0.2500 12.98 12.92 $0.06
12/8/2004 12/7/2004 0.2500 14.26 14.11 $0.15
8/16/2004 8/13/2004 2.2500 14.29 12.04 $2.25

Source: Yahoo!Finance, Author analysis.

However, in looking at the data only twice did the price fall exactly the same as the amount of the dividend. In one case, the opening price was the same as the previous closing price. Furthermore, there were many times when the opening price the next day was lower, but by an amount less than the dividend. Variations would be expected since things happen over night that impact the stock price in addition to the actual dividend reduction.

The average decline was $0.253 and the average dividend was $0.304. With transaction costs, it seems like a dividend capture strategy would be challenged to work. For example, you have both brokerage costs and bid ask spreads to consider. A $10 commission on brokerage trades and using a lot of 1000 shares would erode 2 cents from my previous mentioned margin.

However, if one were able to buy and sell at the closing and opening prices for Frontier in sufficiently large blocks to overcome brokerage trading commissions, this would have been, in theory, a slightly profitable strategy. The next issue is that I don't think there is a way to capture the closing and opening prices with certainty and that would probably be all that was necessary to erode the remaining spread to nothing or even negative. It was also not clear how much volume transacted at the open and close prices, allowing one to enter and exit their position.

To me this shuts the door on the belief in dividend capture as a profitable strategy. This is not to say that you couldn't try the trade and make a profit. After all, the spread in the December 2007 dividend was 0, meaning that if you did get the close and open (and ignoring transaction costs) it was a free dividend. The challenge is knowing when these situations will occur.

However, if many people believe in dividend capture and attempt this strategy, perhaps there is a way to profit from that behavior. In previous articles describing dividend capture, authors discuss trading behavior and other aspects. Perhaps clever investors could profit from this phenomenon. However, I suspect the entities that could make this work would be leveraging infrastructure similar to that of high frequency trading shops that seek to capture benefits from the smallest price fluctuations and discrepancies using powerful computers and rows of Ph.Ds creating new algorithms. I would feel that in this area the odds are sufficiently stacked against me. In contrast, I think I have better odds for success at making fundamental calls about stocks, e.g., Netflix (NASDAQ:NFLX) or FTR itself. I could not advocate for dividend capture.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.

Source: Frontier Communications And Dividend Capture