Why not buy just before the dividend, then sell?

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 payments, as shares of stock, or other property.

Many years ago, unscrupulous brokers engaged in a sleazy sales tactic where they bought stock for their clients just before the dividend was paid and sold right after. These brokers would tell their clients to purchase shares in a particular investment that would supposedly offer profits from an upcoming dividend.

In theory, this may seem like a sound investment strategy, but it is nothing more than an illegal marketing scheme. For example, if Company A is trading at $20 a share and is about to offer a $1 dividend and you hurry to buy a share before the ex-dividend date, you would receive the dividend on the dividend payment date and make an easy 5% return.

In actuality, however, the company's stock price should decrease on the ex-dividend date by about the same amount of the dividend to eliminate this form of arbitrage. So, if you purchased stock before the ex-dividend date, you would get the $1 cash dividend, but this would be offset by the simultaneous $1 drop in the stock price. Thus, buying a stock before a dividend is paid and selling after it is received has absolutely no value except a partial return of the capital invested in the stock in the first place.

To make things worse, dividends create a tax liability, meaning you'll have to claim the dividends as taxable income on the following year's income tax return. Waiting to purchase the stock until after the dividend payment may be a better strategy because it allows you to purchase the stock at a lower price without incurring dividend taxes.

To read more on dividend dates, see Declaration, Ex-dividend, and Record Date Defined.