Dividend stripping is a securities trading practice where people buy securities just before the issuer distributes dividends and sell them after the distribution. Investors have historically used this tactic for tax advantages, and some nations have made changes to their tax codes to eliminate the loophole that previously allowed people to do this. Individual investors and institutions alike can engage in dividend stripping, and in cases where there are no tax benefits, there may be other reasons to handle securities this way.
At the time of purchase, the securities are usually valued high because people anticipate dividends. When the shareholder goes to sell them, they have usually lost value. This can allow the shareholder to declare a loss after selling the securities. The loss offsets the capital gain the shareholder made from the dividend distribution. When people manage dividend stripping well, they can make a profit without having to pay high taxes, if the tax system allows them to do this.
People have to be careful when they engage in dividend stripping. If the securities fall dramatically in price, the income from the dividends may not be enough to offset the loss from the sale, or the investor might barely break even. After considering the costs associated with buying and selling securities, the move might turn out to result in a net loss, rather than a gain. Investors may consider historic performance of those securities, along with weighing whether they can hold on to them if they experience a steep decline in value.
Some nations recognize dividend stripping as a tax avoidance strategy. To curb it, they do not allow people to claim losses on assets they only hold for a short period of time. For example, someone buying securities on Monday and selling them on Friday at a loss could not claim a loss. Commonly, people must hold securities for at least three months before they can sell them at a loss and claim it on their taxes. Strategic investors may be able to hold on to securities that long, while others cannot.
Institutions can use dividend stripping at a very large scale, purchasing huge volumes of securities. This can offset risks, as a failure to do well with one security will cancel out when weighed alongside successful investment with others. Analysts and buyers at institutions make decisions about the kinds of transactions they want to proceed with, and when, timing purchases and sales for the most advantageous moment.