Dividends are corporate profits paid out to shareholders. Booked profit is an asset. A stock price includes the dividend that has not yet been paid. When a company pays a dividend, the asset side of the balance sheet is reduced by the amount of the dividend, so the stock value decreases proportionately. A dividend payment can cause a drop in stock price, but it is likely to be temporary because the longer-term effects of dividends stem more from company profitability, growth prospects and investor expectations than from accounting adjustments.
When a company declares a dividend, it sets a record date and a payment date. Registered shareholders on the record date are entitled to the dividend, which is paid later, on the payment date. Since stock trades settle in three business days, brokers also set an ex-dividend date to make it easier for the buyers and sellers to know who will get the dividend. If an investor buys a stock prior to the ex-dividend date he will receive the dividend; if he buys it on or after that date, he won’t: the dividend will be paid to the previous shareholder, the seller.
Stock Price on Ex-Dividend Date
Up to the ex-dividend date the stock price includes the dividend that the shareholder will receive. On or after the ex-dividend date it does not, so the stock price on the ex-dividend date drops by the dividend amount.
Investor Expectations and Stock Price
Investors always look to the future. Once a dividend is paid, they focus on a company’s profitability and growth prospects, and the stock price begins to reflect those expectations rather than past dividends. Stocks price in, or discount, future events ahead of time. Investors always look to the future. Once a dividend is paid, they focus on a company's profitability and growth prospects, and the stock price begins to reflect those expectations rather than past dividends.
When a company increases dividends over time, it creates a rising income stream that can protect income investors from inflation. Investors often value dividend increases more than the actual dividend yields. Stocks of companies that increase dividends over time tend to appreciate in price roughly in proportion to the dividend increases, even though their prices may temporarily drop on each ex-dividend date.
- “PassTrak Series 7: General Securities Representative License Exam”; Dearborn Financial Services; 2003
- SEC.gov: Ex-Dividend Dates: When Are You Entitled to Stock and Cash Dividends