Many companies reward their owners -- their stockholders, that is -- by paying them a share of the company's profits as a dividend. A dividend usually lowers a company's share price -- but this effect occurs well before the company actually pays the dividend. It actually happens on the "ex-dividend date." The reason lies in the mechanics of the dividend process.
Companies that pay dividends don't just surprise their shareholders with a nice check. They announce the dividend well in advance, and the announcement lays out a schedule that has three critical dates. The "payable date" is the day on which the company will actually pay the dividend. At least a week before the payable date is the "record date"; anyone who is listed in the company's records as a stockholder as of this date will receive the dividend. And then there's the ex-dividend date, or "ex-date." This comes two business days before the record date. If a share changes hands on or after the ex-date, the seller, not the buyer, will receive the dividend. So the ex-date is the true cutoff date for receiving the dividend.
Importance of Ex-Date
A common question is why the ex-date, rather than the date of record, is the cutoff. Stock transfers must be recorded in a company's books on the third business day after a sale. Setting the ex-date at two business days before the record date guarantees that anyone who bought shares before the ex-date -- in other words, at least three days before the record date -- will be a shareholder of record.
Dividends and Share Prices
Remember what a dividend is -- it's a distribution of a portion of the company's net worth. Suppose Company X has 100 million shares outstanding at a current value of $10 a share and pays a dividend of 25 cents a share, for a total of $25 million. When the company parts with $25 million of its cash, the net worth of the company itself falls $25 million. Each share of ownership in the company -- each share of stock, that is -- is worth a little less. To be precise, 25 cents less -- the amount of the dividend. The share price, then, will fall by 25 cents, to $9.75.
Ex-Date and Share Prices
If you own one share of Company A stock before the dividend, you have $10 worth of value. After the dividend, you still have $10 worth of value -- but it's divided into a share of stock worth $9.75 and a 25-cent dividend. Even though this shift in value won't "really" happen until the payable date, it gets set in stone at the ex-date. Once that date arrives, each share is worth $9.75 because the other 25 cents is now spoken for. That's why on the ex-date, you can expect the price of the stock to drop by roughly the amount of the dividend.
It should be noted that the price of the stock may rise in advance of the ex-date. If Company A was at $10 when it announced its dividend, investors looking to score an easy gain from the dividend might pile into the stock, pushing it up to $10.20 or so. At the ex-date, the share price will then drop to a level very close to its original price. The Securities and Exchange Commission says that the larger the dividend, the more likely this is to happen.