Almost every dividend investor is guilty of this bad habit at one point, and if you’re doing it, it’s costing you money. Here’s how to stop making this costly mistake and how to turn it around to start making you money.
It seems like an easy and surefire way to generate higher returns from high-yield stocks. Dividend capture is the strategy of buying shares of a stock just before it goes ex-dividend and then selling those shares soon after the ex-dividend date.
If you own the shares when the market opens on the ex-dividend date, you will receive the dividend payment. With this strategy, the goal is to earn the dividend by owning the stock for just a few days rather than holding shares through a full quarter of share price swings up and down.
The idea is then expanded with the expectation that you can use the same money to buy different dividend stocks more often. Possibly earning 6 or 7 or 8 dividends over the course of a year, rather than the four dividends from a dedicated buy-and-hold strategy. In theory, dividend capture seems like a relatively easy and safe way to significantly boost the income an investor would earn.
Here are the problems with successfully implementing a dividend capture strategy. First, the stock market has a built-in mechanism to eliminate the profit of trading a stock to just earn a big dividend payment close to the ex-dividend date. On the ex-dividend date, when buying shares will no longer result in receiving the upcoming dividend, the stock price opens at the previous day’s closing price minus the dividend amount.
For example, Dividend Hunter recommended stock New Residential Investment Corp. (NYSE:NRZ) went ex-dividend for a $0.48 per share payment on March 23. As you can see from the chart below, on March 22, NRZ closed at $17.09 per share. On March 23, it opened at $16.65, down by $0.44, very close to the dividend amount. The dividend capture traders now must wait for NRZ to climb back up to whatever price they paid for the shares to have a profit equal to the dividend amount.
The bigger problem involves all the other novice investors who have “discovered” the possible returns of dividend capture. The stock market is a pure demand driven auction market. This means that as demand increases so will share prices. Values fall when there are more investors who want to sell than there are ready buyers. You can see where this is going.
As an ex-dividend date approaches, buying demand picks up and so does the share price. After the ex-dividend date, all those dividend capture traders are looking for the first opportunity to unload those shares, so there is much more selling pressure on prices than there is buying demand.
Since most investors are impatient, many will just throw in the towel and sell their shares at a lower price, without waiting for the share price to recover to pre-ex-dividend levels. The result is often a share price increase just before ex-dividend and a continued decline in the share value after the ex-dividend date. Look at the NRZ share price run-up just before this most recent ex-dividend in the chart on the last page.
I have researched and observed this price action for dozens of high-yield stocks over a half-dozen years of quarterly ex-dividend periods, and my analysis shows it is very, very difficult to make even a portion of the dividend yield through dividend capture. The share price run up before ex-dividend and then declines after occurs during most quarterly dividend periods.
If there is a tendency for the share price of a high-yield stock to be driven higher before the ex-dividend date and then fall after, we can employ some contrarian strategy to improve the overall results from our high-yield stock holdings.
These price swings give us the opportunity to buy low when others are selling for the wrong reasons. I personally use the post ex-dividend share price drops as opportunities to add to my holdings in the high-yield shares of stocks like NRZ, AMZA, and STWD.
You should look to do the same. Just by doing this you will increase the average yield of your portfolio and the amount of your future cash dividend earnings.
Also, if your timing is somewhat lucky, you can turn the losses from the dividend capture crowd into your short-term gains. For example, you buy 200 shares of NRZ at a nice low price after ex-dividend. Then as the next ex-dividend date approaches the share price jumps up by $1.00 or more higher than what you paid for your shares. At this point, you can sell that last group of shares you bought and lock in that more than $1.00 gain, which is over double the $0.48 per share dividend you would earn by holding through the ex-dividend day.
After ex-dividend, if the shares fall you can buy them again. This is an entirely optional trade, based on what the share price does. If the “reverse dividend capture” strategy gets the right share price move, you can make some extra profit. If it doesn’t, you still own shares of a quality stock paying an 11% plus yield. That is a win-win way to manage your high yield stock holdings around the ex-dividend period
Earning consistent monthly income from your dividend stocks is not easy. Many investors spend hours researching what stocks to buy, only to end up more confused than when they started.
There are thousands of stocks to choose from, but only a small percentage of that group are the right stocks for you to own. The best high-yield stocks need to have safe long-term businesses that print money every year no matter what so they can pay you consistent dividends.
That’s a tall task for most companies, and unless you have a degree in finance or worked on Wall Street, picking the best companies to own, out of all of the other ones, is extremely difficuly.