Dividend stripping is a strategy where an investor buys a stock just before its dividend is paid, collects the dividend, and then sells the stock shortly afterwards.

In most cases dividend stripping does not work. For most individual investors, dividend stripping is not a reliable way to make money.

At first glance, it sounds like free money, but in practice it rarely works that way.

When a company pays a dividend, the stock price usually falls by approximately the amount of the dividend on the ex-dividend date. This happens because the company’s cash has been reduced by the dividend payment, so the shares are worth slightly less.

For example, imagine a stock is trading at $100 and announces a $3 dividend. If you buy the stock before the ex-dividend date, you will receive the $3 dividend. However, on the ex-dividend date, the share price may open at around $97. You have gained $3 in cash but lost about $3 in the value of your shares, leaving you in roughly the same position before considering taxes and transaction costs.

There are also several costs that can make dividend stripping unprofitable. Brokerage fees, bid-ask spreads, and taxes on dividends or capital gains can reduce or eliminate any potential profit. In addition, the share price may fall by more than the dividend amount if negative news or broader market weakness affects the stock.

That said, dividend stripping can occasionally produce profits. The stock price does not always fall by exactly the dividend amount. If investors remain optimistic about the company’s future, strong buying demand may cause the price to recover quickly after the ex-dividend date. In those situations, an investor might receive both the dividend and benefit from a rising share price. However, this outcome is uncertain and cannot be relied upon as a consistent strategy.

In Australia, some investors are attracted to dividend-paying shares because of franking credits, which can increase the after-tax value of dividends for eligible taxpayers. Even so, Australia has tax rules, including holding-period requirements and anti-avoidance provisions, that are designed to prevent investors from buying shares solely to capture dividends and associated tax benefits. These rules mean dividend stripping is generally not a simple or guaranteed strategy.

Many experienced investors prefer a different approach. Rather than buying shares just before the dividend and selling immediately afterwards, they invest in high-quality companies with a history of paying sustainable and growing dividends. Over time, they benefit from both the dividend income and any long-term growth in the share price. This approach is generally considered more dependable than trying to profit from short-term dividend capture.

In summary, while dividend stripping can work in isolated cases, it is not a dependable source of profit. The expected drop in the share price, combined with taxes, trading costs, and market uncertainty, means there is usually no “free money.” For most investors, selecting strong businesses and holding them over the long term is a more effective way to build wealth than attempting to capture individual dividend payments.

Lauren Hua is a private client adviser at Fairmont Equities.

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