What is Dividend Stripping?
It is a stripped down version of dividend investing!
The strategy of dividend stripping involves buying a stock for the sole purpose of accessing the dividend and accompanying franking credits (if they apply in your country).
The aim is to make a short-term gain on the assumption that the stock price recovers soon after the stock goes ex-dividend.
How Does It Work?
The expectation (or hope) is that after the ex-dividend date, the stock price will fall by less than the dividend, or (even better), that the stock price recovers in a short period of time.
For countries that allow franking credits, the credits will be icing on the cake for either of the above scenarios.
The recovery in the stock price in the short term may be more likely in a rising (bull) market. But if a capital loss occurs, it may be used to offset capital gains elsewhere in the portfolio.
Of course to invoke this strategy, you need to know the ex-dividend date, the date on which you need to hold the stock in order to receive the dividend. Ex-dividend dates are published in the financial press and on company web sites.
The payment date for the dividend is some weeks after the ex-dividend date.
In Australia, you normally have to hold a stock for 45 days (excluding the buy and sell day) in order to be eligible for franking credits. This requirement is relaxed for small investors.
So you could buy the stock 45 days before the ex-dividend day and sell it on the next day. This would pick up any rise in the share price leading up to the ex-dividend day to offset any drop the following day.
Alternatively, you could buy the stock the day before the ex-dividend day and sell it 45 days later. This would hopefully allow for the recovery in the stock price.
Of course, if the stock price has not recovered after 45 days, you can always hang on to the stock for a longer period, assuming you are confident in a recovery in the stock price.
Investors who don't have access to franking credits in their country would not be restricted by a 45 day rule.
When to Use the Strategy?
As previously mentioned, the strategy is likely to work best in a healthy (rising) market when recovery in the stock price after the ex-dividend date is more assured.
It goes without saying (but I will say it anyway) that choosing a company, or companies, that pay a high dividend yield (with 100% franking if it applies) will offer a greater return.
Not all companies have a high dividend yield for the right reasons. A previous share price drop because of a range of reasons will produce a higher dividend yield, so it is important to understand as much about the company as you can.
Dividend stripping may be a profitable strategy for investors adopting a value investing approach who are looking for more ways to increase investing income in the shorter term.
Applying value investing principles when choosing suitable companies for dividend stripping would insure that if the share price did not recover in the short term after the ex-dividend date, then holding the company for a longer period would be less of a risk.
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