By Nathan Lee, TLE Correspondent
Dividends have been, and always will be, an important component to the average investment strategy. The typical dividend strategy is rather basic (but effective) – purchase a well-reputed, long-term income stock, one that has a history of paying regular dividends. But, that’s far from the only dividend strategy available.
There is a dividend strategy called dividend stripping that takes the typical long-term strategy and flips it on its head. In this article, we will be covering the basics of what “dividend stripping” is, as well as how it works. We will also discuss some of the possible disadvantages of utilising dividend stripping as part of your overall investment strategy.
What Is Dividend Stripping?
Dividend stripping is essentially the process of purchasing shares of dividend stocks right before the ex-dividend date, and then turning around and selling the shares on, or shortly after, the ex-dividend date.
It’s a short-term strategy that’s meant to allow the investor to not only pickup the dividend of the stock, but also achieve a capital gain or loss and, where applicable, a franking credit.
In Australian markets, another method utilising a dividend stripping strategy entails holding on to the stock after the dividend has paid out in order to have the possibility of making a profit within a few weeks. This particular strategy works because some high-quality companies’ stocks (especially the Australian banking sector) have been known to recover the value of the dividends fully within weeks.
How Does Dividend Stripping Work?
Below is the method used most often by investors:
Right before a company goes ex-dividend, the investor buys shares of the stock in order to qualify for the dividend payment.
Then, right after the company goes ex-dividend, the investor sells the stock in hopes of receiving a capital gain or loss (that is smaller than the dividend), in addition to the dividend.
Therefore, when looking to use dividend stripping in your trading strategy, it’s important that you target companies that are historically known to have consistent increasing dividend payouts.
The Potential Disadvantages of Dividend Stripping
While dividend stripping may sound simplistic (it is) and altogether profitable, make no mistake that of the various disadvantages associated with this type of dividend strategy. After all, we’re still talking about investing, and there is never a guarantee.
Below are some of the major potential disadvantages of using dividend stripping as a part of your dividend strategy:
In the current economy, the share market has been especially volatile. And with volatility comes unpredictability, and predictability is a crucial component to successful dividend stripping. As a result, dividend stripping has lost a bit of its appeal in recent years.
The amount of profit received via dividend stripping is usually fairly small, which can make the strategy inefficient depending on other factors, such as market spread, brokerage fees, and liquidity.
Dividend stripping has been proven to be an effective dividend strategy; however, the profits are fairly small for the effort put in, which makes it less appealing to some, especially in a more volatile market. That being said; there is potential to turn a nice profit using dividend stripping.
