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Dividend Capture Strategies
Can They Work?

by Ann Coleman
(AnnC@fool.com)

Alexandria, VA. (November 16, 1998) -- A perennial component of most "get rich quick in the stock market" books is the old Dividend Capture strategy. I ran across it most recently in Wade Cook's "classic," Wall Street Money Machine. (Classy title, eh?)

The Dividend Capture strategy suggests that you buy stocks that have just declared a nice fat dividend, collect the dividend, then sell the stocks, a few weeks later. Just hold each one until after the ex-dividend date. After that, you are assured of receiving the dividend so you sell the stock and look for another dividend to capture. Sounds good. Is it too good?

Like many get rich schemes, there is a grain a truth here along with a very big IF. The truth is that you can, indeed, buy the stock shortly before the ex-dividend date, hold it just long enough to get your name on the books, then sell it and "capture" the dividend. The IF is that you only make money IF you can sell the stock for what you paid for it -- or, hopefully, for more than you paid for it -- enough more to cover transaction costs, ideally. That's not so easy.

Since our Dow Investing strategies only pick high dividend paying stocks, one would think that this would be fruitful ground for the strategy. Let's look at our current highest yielding Dow stock and see if this strategy would work. J.P. Morgan (NYSE: JPM) is currently paying $0.95 per quarter per share ($3.80 per year). The yield at the close of business on Friday was a very respectable 3.73%. Can we capture this dividend? Sure. Can we make money doing so? Let's see.

J.P. Morgan went ex-dividend on September 17. It closed on the 16th at $95.25. On the 17th it never quite got as high as $92.50 (obviously more was going on here than just the dividend adjustment). In fact, the stock didn't clear $95.00 again until October 20, and at one point it was trading as low as $79.50. Meanwhile, on October 15th, you get your dividend check. You hang in there until the 20th and sell your stock at the price you paid. You cleared just under 1% in a month. Hmm. It doesn't take a financial genius to see that that wasn't an investment to write home about.

OK, I can hear you now. J.P. Morgan was in big trouble then because of the Russian crisis -- every body knew that. Only an idiot would try a Dividend Capture strategy on J.P. Morgan this fall. True. No argument from me on that one. Besides, any single example tells you nothing. But I don't recall any instructions to attempt this strategy only when the stock will go up. (Like anyone can tell!)

However, J.P. Morgan does nicely illustrate one of the problems with the Dividend Capture strategy -- you might have to hold your stock much longer than you planned just to break even. You might never break even.

A second problem is that a nice juicy dividend attracts all kinds of buyers. Waiting until ex-dividend day is way too late most of the time, because all those other folks who are playing the same game, or just buying for long-term dividends, start buying as soon as the dividend is declared. Of course, many other market factors are also interacting with the price, but all other things being equal, additional buying pressure would tend to drive the price up.

So let's say you buy in as soon as the dividend is announced and are able to sell at a breakeven price on ex-dividend day. That's probably a best case scenario -- in fact, it's close to impossible in cases where the dividend is big enough to notice, but we will grant that it is possible sometimes for the sake of argument. In most cases, you will have to hold the stock for at least a week, and on average, closer to three weeks.

Let's say you really get into Dividend Capture and are able to find 20 or so high dividend stocks, and that you can actually manage to capture the dividend with an average three-week hold.

Say your stocks pay an average of 4%. That's 4% annually -- which is only 1% quarterly. Oh. Right. So you put $10,000 to work jumping in and out of those stocks. Let's see how you would do. One percent of $10,000 is $100. Obviously you are going to be using the cheapest broker you can find, so let's assume transaction costs of $7 -- $14 for the round-trip (buying and selling). At the end of the year what have you got?

You traded every three weeks, or 17 times per year, so you made $1700. Your transaction costs were $14 x 17 = $238, for a net of $1462.00. That's 14.63% return on your money before taxes.

Oh, yeah, taxes. These are obviously short-term trades, so you don't get a capital gains break. If you are in the 28% tax bracket, you will pay an extra 8% in taxes on these short-term trades vs. a long-term strategy. Short-term capital gains taxes will run you $409 vs. $292 in long-term gains. Let's consider the difference ($118) between short-term and long-term gains another kind of transaction cost. $1462-$118 = $1344.

Thirteen per cent? You could do better that with 1/100th the work (finding those high dividend stocks won't be easy) and none of the aggravation with the super-safe High Yield 10.

Of course, you could increase your return by turning your money over more quickly and by using a higher investment amount, which will reduce the effect of commissions. Trading $50,000 every two weeks could net you as much as 23% -- slightly less than the RP's average annual return with 100 times the work. Frankly, I would be very surprised to find that anyone was able to successfully capture a 1% quarterly dividend 26 times per year.

What about the really high dividend stocks? I ran a stock screen and found quite a few companies paying 8%. These are usually real estate management companies, which traditionally pay out a higher percentage of their profits as dividends. What generally happens is that the price runs up as soon as the dividend is announced, drops on ex-dividend day, and stays down for a good while after that. Investors aren't stupid.

That's probably my biggest gripe about the Dividend Capture theory. It seems to attract people who are not very familiar with the workings of the market. Its appeal is based on selling the proposition that the rest of the investing world is not very familiar with how the market works, either. It's easy to assume that others are not "on" to such a scheme when it is new to you. Unfortunately, the marketplace is full of sharks who eat naive investors for lunch. Don't be an entree.

For a more extensive treatment of this topic, click over to our Dividends FAQ.

Fool on and prosper!

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Current Dow Order | 1998 Dow Returns


11/16/98 Close
Stock  Change   Last
--------------------
UK   +1  1/8   43.88
IP   +   3/8   45.25
MO   -   3/4   53.31
EK   +   5/16  77.81
                   Day   Month    Year
        FOOL-4   +0.51%   4.02%  15.36%
        DJIA     +1.03%   4.88%  13.95%
        S&P 500  +0.90%   3.38%  17.05%
        NASDAQ   +0.74%   5.10%  18.55%

    Rec'd   #  Security     In At       Now    Change

 12/31/97  206 Eastman Ko    60.56     77.81    28.48%
 12/31/97  276 Philip Mor    45.25     53.31    17.82%
 12/31/97  289 Int'l Pape    43.13     45.25     4.93%
 12/31/97  291 Union Carb    42.94     43.88     2.18%


    Rec'd   #  Security     In At     Value    Change

 12/31/97  206 Eastman Ko 12475.88  16029.38  $3553.50
 12/31/97  276 Philip Mor 12489.00  14714.25  $2225.25
 12/31/97  289 Int'l Pape 12463.13  13077.25   $614.13
 12/31/97  291 Union Carb 12494.81  12767.63   $272.81


              Dividends  Paid YTD  $1092.81
                            TOTAL  $57681.31

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