Why Not Buy Before the Dividend and Then Sell?

At some point for newer investors, an enticing opportunity comes to mind for dividend-paying stocks: Why not buy some shares right before the dividend, collect the money, and then sell them? At first glance, this strategy appears terrific in its simplicity. After all, who wouldn’t want to capture “free money” from a company’s profit-sharing?

However, the reality isn’t so simple. Just as water seeks its own level, financial markets have their way of maintaining equilibrium. When a company pays out a dividend, something interesting happens to its stock price—it should fall by about the same amount as the dividend itself.

This price adjustment reflects a basic economic principle: A company that distributes cash to shareholders has less value afterward than it did before. Think of it as withdrawing money from your savings account – your balance decreases by the amount you take out. Let’s take you through why this is the case.

How Dividends Affect Stock Prices

A dividend is a distribution of a portion of a company’s earnings paid to a class of its shareholders in the form of cash, shares of stock, or other property. It’s a share of the company’s profits and a reward to its investors—the company’s owners.

These cash payments typically arrive quarterly, though some companies pay monthly or annually. Here’s the crucial part many new investors miss: When a company pays out cash as dividends, that money comes directly from its assets. That’s why after a dividend, a company’s value typically drops by about the amount it paid out. If a stock trading at $50 pays a $2 dividend, you might see the stock price fall to around $48 after the payment.

This price adjustment isn’t random— it’s a rational market response. Imagine two identical companies trading at $50 per share, but one is about to pay a $2 dividend while the other isn’t. If the stock price didn’t adjust down after the dividend, investors could theoretically profit by buying just before the dividend and selling immediately after—pocketing a guaranteed $2 profit. Markets don’t allow these kinds of “free money” or arbitrage opportunities to exist for long. That’s why the stock price adjusts downward by about the same amount as the dividend, eliminating the chance for this easy profit.

The date on which the stock usually drops by this amount is called the ex-dividend date. The market price has been adjusted to account for the revenue that has been removed from its books.

For long-term investors, this price drop isn’t usually concerning. They receive the $2 dividend, which offsets the $2 decline in stock value, keeping their total investment value the same. What matters more is the company’s underlying strength and ability to maintain or grow future dividends.

For many investors, dividends are a major point of stock ownership. Long-term investors look to hold stocks for years and dividends can help supplement their income. Dividends can be a sign that a company is doing well. That’s why a stock’s price may rise immediately after a dividend is announced.

This loss in value is not permanent, of course. The dividend having been accounted for, the stock and the company will move forward, for better or worse. Long-term stockholders are generally unaffected. The dividend check they just received makes up for the loss in the market value of their shares.

Day Traders and Dividend Capture

Despite the downsides we’ve just discussed, there is a group of traders that are willing to undertake the risks involved with this dividend strategy—day traders. Day trading involves making dozens of trades in a single day to profit from intraday market price action.

Day traders will use what’s known as dividend capture, or a variation of it, to make quick profits by holding shares just long enough to capture the dividend the stock pays. The strategy requires the ability to move quickly in and out of the trade to take profits and close out the trade so funds can be available for the next trade.

Because day traders attempt to profit from small, short-term price movements, it’s difficult to earn large sums with this strategy without starting off with large amounts of investment capital. The potential gains from each trade will usually be small.

For example, capturing a 50-cent dividend on 100 shares would yield just $50 before taxes. Second, frequent trading typically results in less favorable tax treatment of dividend income.

Most importantly, successful dividend capture requires perfect timing and a deep understanding of market movements. It’s like surfing—you need to catch the wave at exactly the right moment, and even experienced traders sometimes wipe out.

How Dividends Are Taxed

The tax treatment of dividends can significantly impact your investment returns. Not all dividends are taxed the same way, and understanding the differences can help you make better investment decisions.

Qualified dividends from stocks you’ve held for a certain period receive preferential tax treatment. It’s an ordinary dividend reported to the Internal Revenue Service, which taxes it at capital gains tax rates. Individuals earning over $44,625 or married couples filing jointly who earn $89,250 pay at least a 15% tax on capital gains for the 2024 tax year.

However, if you’re frequently trading to capture dividends, you’ll likely face higher taxes. Short-term dividend holdings typically count as “non-qualified” dividends and get taxed at your regular income tax rate, which could be as high as 37%. High-income investors might also owe an additional 3.8% Medicare surtax on investment income.

Foreign stocks add another wrinkle—their dividends might be subject to withholding taxes by foreign governments before you even receive them. While you can often claim a credit for these taxes on your U.S. return, it adds another layer of complexity.

The Bottom Line

While capturing dividends might seem like an easy way to generate quick returns, the reality is that it’s likely not. Stock prices typically adjust downward by the dividend amount, making any attempted arbitrage largely futile. For most investors, focusing on quality dividend-paying stocks as part of a long-term investment strategy makes more sense than trying to capture short-term dividend payments.

Between the tax consequences and market efficiency, dividend capture strategies rarely deliver the easy profits they theoretically promise. Instead, successful dividend investing usually comes from holding shares in financially healthy companies that can maintain and grow their dividend payments over time.