Dividend Stripping

Introduction

If you want to earn money and maximize your profit, then stock investment is the best way to do so. While other tactics are available to investors to maximize their earnings, more experienced investors prefer to opt this investment avenue. Parking your money in mutual funds enables you opt between two options, i.e., growth and value.

You can either let the funds grow by allowing the company to reinvest the dividends or claim them at the time of pay-out. This type of investment allows you to appreciate your capital or gain returns in the form of dividends. The most common practice among a lot of mutual fund investors is dividend stripping. Now, what does this term anyway mean?

Meaning of Dividend Stripping

Investors utilize dividend stripping to profit from a company's dividend payments. A dividend is a payment a firm pays its shareholders in stock shares or cash. Dividends are typically paid quarterly or annually, allowing companies to distribute profits to their shareholders.

Dividend Stripping explained

Dividend stripping involves buying shares of a company just before it issues a dividend and then selling them soon after. This strategy aims to profit from the dividend payment without holding onto the shares for an extended period.

Here's an example of dividend stripping in action. −

Assume that PQY Corporation will pay its stockholders a $1 dividend per share. An investor invests $5,000 in 100 shares of PQY stock for $50 per share. The investor then holds onto the shares until after the dividend is issued. After the dividend is released, the investor sells the shares for $49 per share, for a total transaction price of $4,900.

The dividend payment rewarded the investor $100 ($1 per share x 100 shares), while the sale of the shares gained the investor $100 ($49 per share sale price - $50 per share purchase price).

Dividend Stripping Strategies

Investors can use several different strategies when it comes to dividend stripping. Here are a few to consider −

• Buy and hold − The best strategy is to buy the shares of a company before the dividend is paid out and hold them for as long as possible. This technique is dangerous because the stock's value may fall during the holding term, potentially cancelling the dividend payment benefit.

• Sell before the ex-dividend date − Another option is to sell the shares before the ex-dividend date when the shares lose their right to the dividend payment. This method can assist investors in avoiding the stock price decrease that frequently comes following the ex-dividend date.

• Sell after the ex-dividend date − Finally, some investors prefer to sell their stock after the ex-dividend date but before the next dividend is paid. This strategy can be profitable if the stock price rebounds after the ex-dividend date drop.

Dividend Stripping Conditions

The success of dividend stripping depends on several conditions −

• The company must have a history of issuing dividends regularly.

• The investor must be able to purchase shares for less than the dividend payment.

• The investor must be able to sell the shares for more than the original buying price.

• The investor must carefully examine the trade's timing.

• The investor will not get the dividend payment if the shares are sold after the ex- dividend date.

• The investor may miss out on possible gains if the shares are sold too soon.

Dividend Stripping Tax Implications

Dividend stripping can have significant tax implications for investors. In many countries, dividend income is taxed lower than capital gains. As a result, if an investor keeps their shares for a long time, they may profit from the lower dividend tax rate.

However, investors may face higher taxes on capital gains rates if they engage in dividend stripping. In addition, some countries have specific tax laws that prohibit dividend stripping. Therefore, investors should consider the tax implications before engaging in this strategy.

Remember These Things Before Going for Dividend Stripping

There are certain things to keep in mind before we go for dividend stripping to get the best outcome, such as.

• Understand the risks − Dividend stripping is a short-term trading strategy that can be risky. Investors should carefully consider the risks before engaging in this strategy.

• Do your research − Before investing in any company, investors should conduct thorough research to understand its financial health, dividend history, and other factors that may impact the success of dividend stripping

• Consider the tax implications − As mentioned earlier, dividend stripping can have significant tax implications. The investor should take help from a tax professional and understand the results of such investments.

• Be mindful of market conditions − Market conditions can impact the success of dividend stripping. Investors should consider market conditions before engaging in this strategy.

Conclusion

Dividend stripping is a trading strategy involving buying shares just before a company issues dividends and selling them soon after. This strategy is known to be profitable, but investors should carefully calculate the risk before investing. Investors should conduct thorough research, consult with tax professionals, and be mindful of market conditions before dividend stripping.

FAQs

Q1. What are the conditions for dividend stripping?

Ans. The company must have a history of issuing dividends regularly. The investor should purchase the shares for less than the dividend pay-out and sell them for a profit on the purchase.

Q2. What are the risks of dividend stripping?

Ans. Dividend stripping is a short-term trading strategy that can be risky. The investor may miss out on potential gains if they sell shares too early or after the ex-dividend date. In addition, the tax implications of dividend stripping can be significant.

Q3. Is dividend stripping legal?

Ans. In most countries, dividend stripping is legal. However, some countries have specific tax laws that prohibit dividend stripping. Investors should consult with tax professionals to understand the tax implications of this strategy in their specific country.