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Rotating between dividend payers sounds simple but is tough to execute Add to ...

The low interest rate environment has everyone and their dog looking for yield and income, which means a more aggressive version of dividend capture is bound to get more attention. Essentially, it involves constantly rotating between dividend paying stocks with offset dividend payment dates to dramatically increase your yield. I know I sometimes sound like a broken record, but this is another case of "in theory, theory and practice are the same, but in practice they are not."

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The theory of trying to capture a dividend is simple. You own a dividend paying stock up until it starts to trade ex-dividend. You can even buy it the day before the ex-dividend date and sell it the next day. And yes, you will be entitled to the next dividend payment even though you owned it for only two days.

Sounds great, right? If you could find 25 stocks with quarterly dividend payments that offset enough that you could rotate in and out of them to capture all the dividends, you'd be laughing. Wrong.

There are a number of reasons why this doesn't work as smoothly as it appears to.

Commissions are one big reason. Buying and selling 25 stocks quarterly means 200 trades a year. When you are trading that much you also have to consider the potential capital gains that may drag down your after-tax returns in non-registered accounts.

However, capital gains might be the least of your worries if you consider that stocks are supposed to drop in price on the open of their ex-dividend dates by the amount of the dividend per share to be paid out. That means that in theory, you're more likely to have capital losses.

Then you have to worry about market efficiency. The market doesn't have to be perfectly efficient, it just has to be efficient enough that it can recognize the opportunity of dividend capture. And it does. Prices of stocks tend to run up as they approach their ex-dividend date, and they tend to drop more than the dividend amount. One way to address this is to buy the stock well ahead of the the ex-dividend date and sell it well after the ex-dividend date, to try to capture the initial run up and sell after a post recovery in share price. The problem with this is that it assumes the share price has no other reason to move from one day to the next. The regular share price fluctuations can completely mask the price changes due to the ex-dividend date.

There are a handful of dividend capture strategy mutual funds in the world, so we can look at some real results. An American-based fund with a 10-year track record has underperformed the S&P 500 index over the last one-year, there-year, and five-year periods, but has slightly outperformed over 10 years. Check out this fact sheet. Note that the market-cap breakdown of the holdings indicates that the fund is significantly tilted towards smaller stocks, so in reality the S&P 500 is a poor benchmark for the fund anyways. Having said that, when compared to a Dividend Capture Indices Blend, it underperformed in all time periods. The results, therefore, are inconclusive.

So if everyone and their dog is looking here for higher yield, you may want to look elsewhere. In the case of rotating dividend capture strategies, you might be barking up the wrong tree.



Preet Banerjee is a senior vice-president with Pro-Financial Asset Management. His website is wheredoesallmymoneygo.com.

Follow on Twitter: @preetbanerjee

 

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