What is the Dividend Capture Strategy and How Does it Work?

Dividends are when corporations choose to share some of their earnings with their shareholders. Generally speaking, said process uses cash. However, it isn’t uncommon to see dividends paid out using non-cash assets instead. Since most people like cash as well as other valuable assets, there are numerous dividend-centered investment strategies that can be found out there, with an excellent example being the dividend capture strategy.

In short, the dividend capture strategy is based on buying dividend-paying shares, holding them for a short period of time, and then selling those same dividend-paying shares. This can work because a stock’s share price tends to increase when a dividend has been announced while that same stock’s share price tends to decrease when a dividend has been paid out. However, the dividend capture strategy is not meant for casual investors, seeing as how it requires a lot of trades that must be carried out on a regular basis.

It Is Non-Traditional in Nature

The dividend capture strategy isn’t what one would consider to be the traditional approach to dividend-paying stocks. Generally speaking, people buy dividend-paying stocks with the intention of holding on to them, thus enabling them to collect the dividends in period after period. In contrast, the dividend capture strategy is very short-term in nature, so much so that interested individuals sometimes hold on to the relevant stocks for just a single day’s time. As such, one could say that the two are opposites in nature.

It Favors the Biggest Dividends

Most dividends are paid out on either an annual basis or a quarterly basis. However, there are some examples of dividends that are paid out on a monthly basis as well. Those who choose the dividend capture strategy tend to favor stocks that pay out dividends on an annual basis over stocks that pay out dividends on a quarterly basis, which in turn, are favored over stocks that pay out dividends on a monthly basis. There is nothing mysterious about this. Said individuals do so because the annual dividends are the biggest, thus making it that much easier for them to make a profit through their trades. Other dividend-paying stocks can still be profitable when using the dividend capture strategy. However, the process is much more challenging.

Timing Is Critical

Timing is critical for the success of the dividend capture strategy. For starters, there are four dates that interested individuals have to remember for each dividend-paying stock that they examine for profit-making potential. First, there is the declaration date, which is exactly what it sounds like in that it is the date on which the corporation declares a dividend. Second, there is the ex-dividend date, which is when the stock starts trading without the value of the next dividend factored into its share price. Third, there is the record date, which is when the corporation records which shareholders meet the requirements for receiving the dividend. Fourth, there is the pay date, which is when the corporation pays out the dividend. Out of these four dates, interested individuals need to keep a particularly close eye on the ex-dividend date because they need to buy the stock before it because it is the cut-off date for determining who is and isn’t eligible for receiving the dividend. As such, if they fail to do so, the whole basis of the dividend capture strategy will fall out from beneath them.

The Dividend Capture Strategy Is Simple and Straightforward

The dividend capture strategy needs a lot of effort from interested individuals. However, one of the most important factors for its popularity is its simple and straightforward nature. After all, the basic process consists of buying the stock before the ex-dividend date and then selling the stock on the ex-dividend date. Sometimes, this happens right away. However, if the share price of the stock falls too much on the ex-dividend date, interested individuals might wait for it to recover before choosing to sell. The whole process is possible because shareholders don’t need to hold the share until the pay date for them to meet the requirements needed to receive the dividend.

It Is Theoretically Impossible

Amusingly, one can make the case that the dividend capture strategy is theoretically impossible. After all, if the market was perfectly efficient, the share price of a stock would perfectly reflect the value of the dividend both before and on the ex-dividend date, meaning that interested individuals wouldn’t be able to benefit from the aforementioned trades. However, it is important to note that the efficient market hypothesis is rather controversial in spite of its position of importance in the modern field of finance.

In short, the efficient market hypothesis is the idea that share prices perfectly reflect all of the information that is available to interested individuals, meaning that they are always the fair market value. As a result, there is no point for shareholders to either search for shares that are priced lower than they should be or make an attempt to predict future trends in share prices because they have no hope of success. Instead, the best option for investors is to put their money in a low-cost, passive portfolio because that enables them to benefit from the market while minimizing their costs in the process through not one but two ways.

There is a fair amount of evidence to support the efficient market hypothesis, which is why it hasn’t been tossed out onto a trash heap for sounding so ridiculous. However, there are also people who argue against it with a fair amount of persuasiveness on their side. One, while no one can beat the market 100 percent of the time, said individuals can point to a number of exceptional investors who can do so on a relatively consistent basis, thus undermining the idea that there is no point to both fundamental analysis and technical analysis. Two, said individuals can point to stock market crashes as proof that share prices can deviate a great deal from what should be their fair market values.

Thanks to this, the debate between supporters and opponents of the efficient market hypothesis continues on. However, the relevant part is that while efficient market hypothesis says that dividend capture strategy shouldn’t work, the efficient market hypothesis doesn’t seem to be true all of the time. Due to this, there is room for the potential profitability of the dividend capture strategy.

It Is Not Profitable 100 Percent of the Time

Having said that, the dividend capture strategy is not guaranteed to be profitable 100 percent of the time. If it was, it would be exploited by computerized systems, which can move much faster than what humans can manage on our own. Instead, it is very important that interested individuals exercise their personal judgment when it comes to the dividend capture strategy so that they can jump on good opportunities while avoiding bad opportunities. Moreover, they have to do so fast because of the importance of timing for the dividend capture strategy. On the plus side, this isn’t the most difficult of the investment strategies that can be found out there, meaning that the amount of time and effort needed isn’t quite as bad as it might seem.

Transaction Costs Are a Huge Concern

Transaction costs are a huge concern for the dividend capture strategy. This should come as no surprise because its success is reliant on numerous trades. As such, interested individuals need to make sure that their profit calculations are factoring in their transaction costs for improved accuracy. Even so, one of the biggest problems with the dividend capture strategy is that potential gains tend to be quite small, meaning that a larger number of shares might be needed to realize a sizable profit. Meanwhile, potential losses can be quite high if something bad happens during the holding period for the dividend-paying shares. In such scenarios, interested individuals can choose to lock in their losses by selling in spite of the fall in share price. However, they can also choose to hold on to the shares until the share price recovers, which will expose them to the risks of holding on to the shares in the process. In this as in other things, there are trade-offs.

Best When Used on Blue Chips

Due to this, blue-chip stocks tend to be the best choices for the dividend capture strategy. In short, blue chips are corporations that have a combination of firm foundations, sound finances, and very widespread recognition. Thanks to this, they can be considered the cream of the crop when it comes to stocks, which is why they are often included in the best-known stock market indexes. There is no such thing as a universal definition for which corporations can be considered blue chips and which corporations cannot, but interested individuals should know that a common requirement is a market capitalization of $5 billion, meaning that blue chips are corporations such as Coca-Cola, Disney, and McDonald’s. In any case, there are a couple of reasons why those practicing the dividend capture strategy should go for blue chips as opposed to other companies. First, blue chips tend to give good dividends because they are mature companies with stable earnings, thus making them attractive options from the consideration of getting a good return. Second, the very nature of blue chips means that they don’t experience a lot of sudden negative events, meaning that there is very little risk of investors being forced to hold on to them after getting the right to receive the next dividend. As for why blue chips are called blue chips, the answer is that they are a reference to poker. Traditionally, the simplest sets of poker chips come in white, red, and blue, which are listed in order from the teast valuable to the most valuable. In other words, blue chips are called exactly what they are in the world of stocks.

Can Be Used on a Constant Basis

Still, the dividend capture strategy can be used for other stocks as well. For that matter, it isn’t limited to just domestic stocks, seeing as how international stocks are also options. On top of that, there are even exchange-traded funds that give out dividends to those who hold shares in them. Combined, this means that interested individuals are never without opportunities for making a return through the dividend capture strategy. This is good because their gains on each share are likely to be small, meaning that they need to make up for that in some way if they want to increase the benefit to them. Buying and selling in bulk would be one way, while engaging in more dividend captures would be another.

There Is a More Sophisticated Version

Some people might have seen a more sophisticated version of the dividend capture strategy that uses options, which are derivatives that let their holders either buy or sell the underlying asset at a pre-specified price at a future point in time. Options are complicated tools by their very nature, meaning that interested individuals should be very careful when it comes to their use.

For an example of how options can be used for the dividend capture strategy, consider the idea of using a put option to protect from the risk of the fall in share price on the ex-dividend date. Essentially, put options are options that give their holders the right but not the obligation to sell the underlying asset at a specified price at a specified time in the future. As a result, they enable interested individuals to sell the no longer useful shares at a share price that is beneficial for them even if it has fallen beyond what is acceptable to them. Be warned that options have two major components to their value, which are time value and intrinsic value. The latter is the value of the option based on the latest share price. Meanwhile, time value is based on the potential for the option to become useful, which is a mix of the time until its expiration and the volatility of the underlying asset.