When a company makes a profit, it has a number of choices as to how it can spend this money. In some cases, the company will reinvest the money in the business, such as in new capital operations, or it will use it to pay down debt. However, other times, the company will give this money back to shareholders in the form of dividends. Stock prices will usually increase after dividends are announced, but before they're issued.
A dividend is a payment made by a company to shareholders that represents profits. Each shareholder receives a certain amount of dividends based on the each share of stock owned. For example, if a company issues a dividend of 30 cents per share, then the stockholder will receive 30 cents for each share he owns. Companies usually announce the size of dividend payments shortly before issuing them.
Because each shareholder receives a certain amount of money from the company for each share that they own, the share price of the stock will reflect this payment. So, if a company announces a dividend in the future, the market will reconsider the value of a stock accordingly. If the dividend payment is unexpected, the price will usually rise to reflect the future payment to shareholders.
However, some companies issue dividends consistently, usually every financial quarter. In many cases, because an investor is already expecting the dividend, the price of the stock will not rise when the dividend is formally announced. In fact, if the size of the dividend is smaller than the market expected, then the price of the stock may actually fall, as the stock may now appear less valuable than investors previously thought.
If the price of the stock does rise slightly before the dividend, or if the price simply stayed the same, the share price will generally fall slightly after the dividend has been issued. This is because the stockholder who just received a check for the dividend will not receive another for at least several months (unless the company announces a one-time payment) so the stock is priced down accordingly.
- "Investing For Dummies"; Eric Tyson; 2008
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