Passive earnings from securities are a goal for many investors. However, achieving this requires understanding the processes of dividend accrual and stock price fluctuations. To secure such income, let’s explore how securities behave before and after dividends are paid, and determine when is the best time to sell dividend stocks.
Key Terms
First, it’s essential to understand some key terms that will be discussed further: record or cut-off date, T+2 (T+1) trading mode, and dividend gap. These should be familiar to every shareholder of dividend-paying stocks.
Record or Cut-Off Date
This term refers to the date on which the shareholder register is closed. On this day, the company lists the individuals eligible to receive dividends. Depending on the company’s Charter and dividend policy, payments may occur annually, semi-annually, or quarterly. Since this frequency varies among companies, potential investors should verify it before purchasing securities. The cut-off date is fixed before each payment.
Only shareholders who hold the shares on the cut-off date will receive dividends. Those who purchase shares after the cut-off date and before the actual payment will not receive dividends for the past period. They must wait for the next period and hold the shares until the new cut-off date if the company decides to pay dividends.
Trading Mode Т+2 (T+1)
T+2 is a trading mode used on many global exchanges. According to this mode, a person becomes the actual owner of the shares two days after the transaction (settlements occur on the second day after the purchase). If the cut-off date falls within these two days, the previous owner will receive the dividends. For example, if someone buys a package of shares on the 23rd, they will become the actual owner on the 25th. If the cut-off date is the 24th, the previous owner will receive the dividends.
Holidays and weekends are not included in these two days. For instance, if the cut-off date is the 5th (Monday) and the 3rd and 4th are weekends, the transaction must be completed by the 31st (or 30th) of the previous month to ensure ownership by the cut-off date. Otherwise, the shares will still be registered to the previous owner, and you will not receive the dividends.
In T+1 mode, everything mentioned about T+2 applies. However, final settlements occur the next day, reducing the time lag by one day. After May 28, 2024, all stock exchanges in the USA, Canada, and Mexico operate in T+1 mode. This mode also applies to exchanges in China and India, while Australian and European exchanges still use T+2.
Dividend Gap
This term refers to the decline in stock price that occurs on the trading day following the dividend record date. Generally, the gap is roughly equal to the amount of the dividend, but it can be larger or smaller depending on various factors. Price recovery (closing the dividend gap) takes anywhere from a few days to several months. It depends on the company’s potential and the economic situation in the securities market. Sometimes, the gap doesn’t close at all, but this happens in less than 10% of cases.
How Do Stocks Behave Before and After Dividend Payments?
Typically, stocks increase in price after the decision to pay dividends is approved by the General Meeting of Shareholders up until the record date, and then they lose value immediately after the record date. This pattern is common for various companies but can be influenced by additional factors. Stock prices can also be affected by the following:
- Company’s market position. For instance, in 2020, American airline stocks fell significantly due to border closures and flight cancellations, despite dividend payment decisions. In contrast, trading platform stocks gained an advantage.
- Factors driving price growth. Stock prices cannot solely rely on shareholder interest. The company must increase turnover and secure new trade contracts to ensure future profits.
- Stability of growth. Some issuers’ stocks may show hundreds of percent growth in a short time but later lose it during corrections. Such fluctuations lead to low ratings from traders and potential issues with closing the dividend gap.
- Other influencing factors. Legal proceedings, shareholder exits, or changes in company management can also impact stock prices. These need to be monitored if you plan to purchase a stock package.
When to Buy Stocks to Receive Dividends?
Guaranteed dividend payments are received by shareholders who acquire the stocks two working days (in T+2 mode) or one day (in T+1 mode) before the dividend record date. For example, if the company closes its shareholder register quarterly on the 5th, a potential investor should buy the stocks on the 1st, 2nd, or 3rd to be sure to appear on the shareholder list.
However, this strategy usually doesn’t bring substantial income since stock prices always rise a few days before the payouts. To maximize income, a trader should purchase the stocks 2-3 weeks before the record date. Some start buying stocks right after the financial report is released, calculating potential dividends themselves. However, this approach isn’t always rational, as the final decision might differ from preliminary recommendations, the dividend share might be reduced, or payments might be canceled altogether.
It’s not advisable to trade stocks immediately after the record date since they traditionally drop in value. But this price drop could be advantageous for long-term investment strategies.
How Long Should You Hold Stocks to Receive Dividends?
Every trader decides how long to hold the securities of a particular company. It’s better to follow your trading strategy rather than specific dates. Technically, you can sell the stocks the day after buying them. If a trader times this with the record date, they can receive their dividends. However, conducting a transaction during this period might be challenging. During this time, prices will fall, and potential investors will postpone purchases, watching the company’s economic indicators such as profit levels, ranking position, and other factors.
Selling Dividend Stocks After Dividend Payouts
Technically, the timing for selling dividend stocks can be any time, and the investor can conduct such a transaction even the day after the record date. But if you want to achieve higher profits, you should wait. This allows you to better analyze the upcoming transaction, considering the company’s position and expected dividend amount, and thus conclude a more favorable contract if you decide to sell the securities. Additionally, in 90% of cases, the dividend gap closes, meaning you can gain not only dividend income but also speculative profit.
Going short on stocks in anticipation of the dividend gap is also quite possible. However, for such a trade to be successful, you need to:
- Consider the dividend amount. Typically, the gap is approximately equal to the dividend, so you can fairly accurately determine the transaction’s profitability.
- Take into account the company’s performance indicators.
- Execute the sell transaction before the record date. The price drop occurs very quickly after the record date, making it challenging to secure the best price.
Example of a Dividend Stock Strategy
Let’s take a company with stable growth indicators, new contracts, and a $10 per share dividend payout. Suppose its securities are priced at $100 each.
In any case, purchasing before the record date will yield a $10 dividend payout, equivalent to a 10% return. After the record date, even if the dividend gap is just 10%, investors can profitably buy these securities. If the gap closes, the pre-dividend purchase stocks will break even, and the new ones will generate an additional 10% annual return. With the inevitable further increase in stock price (since the company maintains its market position), the securities can be sold successfully.
This strategy can only be used with the securities of large companies showing stable growth. Otherwise, you risk investing in stocks that quickly lose value and do not recover in the future.
Is It Worth Shorting a Stock or Its Futures During the Record Date?
Selling stocks and their futures during the record date is pointless because both assets experience rapid price changes during this period. As mentioned earlier, securing a good price in such a transaction is very challenging.
Some traders prefer to hold onto their securities during this period but sell futures on them. However, not all buyers are willing to enter such trades. This is because predicting the future behavior of the futures is extremely difficult. Nevertheless, this approach can be quite interesting if you follow the previously mentioned conditions for entering a short position. In this case, the stocks will provide dividend income, and selling the futures before the record date will hedge against their drop after the record date, allowing you to profit from the dividend gap.
Thus, answering the question of when to sell dividend-paying stocks is quite complex. The only definite solution is to hold the securities until the dividend record date. Beyond that, the investor must evaluate their trading capabilities, the stock performance, and the issuer’s business characteristics.
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