• Dividend hopping causes high transaction costs
• High withholding taxes make foreign titles unattractive
• If dividends are tax-free, it is worth buying before the ex-date
Dividend stocks are more popular than ever before in the current phase of zero and negative interest rates. While the Confederation’s ten-year bonds were in negative territory throughout 2019, the dividend yield of the Swiss Market Index SMI averaged around three percent.
Collecting dividends is not always worth it
However, this raises the question for dividend investors: “Should you buy shares before or after the ex-dividend date?” Although most investors are happy when they receive a dividend immediately after their investment, this is not always as worthwhile as one might think.
Purchase before the ex-date
In Switzerland, most general meeting dates fall in March and April, which is why this period is also known as dividend season. It is crucial for the investor who wants to receive a dividend that he has his shares in his portfolio before the regular general meeting and therefore owns them on the so-called dividend record date or before the ex-dividend day. Immediately after the shareholders’ meeting, at which the amount of the distribution is approved by the investors, the shares of the respective group trade ex-dividend, i.e. with a dividend discount. The exact dates for the ex-date, dividend record date, general meeting and the exact distribution date can be found on the websites of the individual companies.
On the ex-dividend day, the price of the respective share is usually reduced by the value of the dividend paid out. This reduction is made by the market as a whole and, depending on the market situation, is slightly higher or lower than the actual dividend. Investors who buy a share shortly before the ex-date and then immediately sell it again can receive a dividend, but may lose this amount in the price of the share. Accordingly, one can often observe that large dividend stocks record enormous price gains a few days before the ex-date because some investors still want to get on the “dividend bandwagon”.
Transaction costs and fees
Investors who engage in dividend hopping, i.e. regularly buy before the ex-date and sell immediately afterwards, incur high transaction costs and thus reduce part of their income. Furthermore, the tax aspect of the distribution must not be ignored. A tax is due immediately on the dividends paid out; if they come from abroad, a withholding tax is also due. Depending on the country of origin, this withholding tax is between 10 and 35 percent. Although foreign withholding taxes can be refunded to a certain extent, this is often associated with bureaucratic effort.
Tax-free dividend
Domestic companies can also distribute half of their dividends to shareholders tax-free. However, this only applies to distributions from capital reserves, i.e. the funds that were made available to the group by the lenders at an earlier point in time. However, only Swiss investors who keep the shares in their private portfolio can benefit from this partial tax exemption. In such a case, it may well be worthwhile for investors to take advantage of the stock before the ex-dividend date.
Purchase after the ex-date
Since the dividends paid are usually deducted from the share price on the ex-date, dividend hopping is not worthwhile. This procedure is extremely unfavorable, especially with foreign stocks, due to the withholding tax that is incurred. Accordingly, for some stocks from countries with high withholding taxes and very bureaucratic refund procedures, it is only worth buying after the ex-date. Entering after the dividend has been paid also offers the advantage that the price is slightly cheaper and therefore offers new potential, since in a positive market environment the dividend discount is often made up very quickly. Furthermore, the future price-earnings ratio falls on the ex-dividend day, which makes the share fundamentally appear somewhat cheaper.
The business model and not the dividend is crucial
Accordingly, it does not necessarily make sense for investors to purchase shares immediately before the dividend payment. Furthermore, the dividend should not be viewed in isolation, but should always be placed in a future context that takes into account the longevity of the respective business model. “A company’s business model is just as important. A high dividend yield is only attractive if the distribution is based on a healthy balance sheet and continued stable cash flow development,” said an analyst at Bank J. Safra Sarasin. Furthermore, extremely high dividends always carry a risk of future cuts.
Pierre Bonnet / finanzen.ch