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From Personal Finance for Dummies, page 209:

Dividends
Dividends are income paid by investments. Both bond funds and stocks can pay dividends. Bond fund dividends (the interest paid by the individual bonds in a fund) tend to be higher (as a percentage of the amount you have invested in a fund). When a dividend distribution is made, you can receive it as cash (which is good if you need money to live on) or reinvest it into more shares in the fund. In either case, the share price of the fund drops to offset the payout. So if you’re hoping to strike it rich by buying into a bunch of funds just before their dividends are paid, don’t bother. You’ll just end up paying more in income taxes.

It is talking about mutual funds.

I've never played with stocks. However, I would like to know more about it. Does the bold text imply the stock price will drop because of a company giving out a dividend?

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6 Answers 6

Yes, the stock price drops on the ex-dividend date by roughly the amount of the dividend. There is even academic research testing this and confirming that the popular rule of thumb works well.

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Here's a thought I'm sure has been thought of before -- because of the above behavior, would it not be a strategy to short stocks before their dividend dates? With some leverage that could prove rather profitable I'm sure. Is this widely practised? –  Doggie52 May 19 '13 at 21:52

The Paragraph talks about dividends given by Mutual Funds. Say a fund has NAV of $ 10, as the value of the underlying security grows, the value of the fund would also grow, lets say it becomes $ 12 in 2 months. Now if the Mutual Fund decides to pay out a dividend of $ 1 to all unit holder, then post the distribution of dividend, the value of the Fund would become to $ 11. Thus if you are say investing on 1-April and know that dividends of $1 would be paid on 5-April [the divided distribution date is published typically weeks in advance], if you are hoping to make $1 in 5 days, that is not going to happen. On 6-April you would get $1, but the value of the fund would now be $11 from the earlier $12. This may not be wise as in some countries you would ending up paying tax on $1.

Even in shares, the concept is similar, however the price may get corrected immediately and one may not actually see it going down by $1 due to market dynamics.

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+1 for showing a complete history ($10 -> $12, distribute $1 and drop to $11), often lacking in other write-ups I have read. –  ChrisInEdmonton Sep 28 '11 at 15:51
    
In the US you would pay tax on the $1 at the dividend tax rate, but you would also generally be able to deduct the $1 drop as a capital loss (subject to all the rules for handling capital losses). –  fennec Feb 26 '12 at 21:23
    
@fennec "...deduct the $1 drop as a capital loss (subject to all the rules for handling capital losses)." This is incorrect. Even though the shares are bought for $12 on April 1 and the price is $11 on April 6 due to the dividend distribution, there is no capital loss that can be deducted unless the shares bought on April 5 are sold on April 6 (or any other day) for less than $12. –  Dilip Sarwate Feb 26 '12 at 22:48
    
yes. that is one of the (many) rules about capital loss deductions. –  fennec Feb 27 '12 at 6:38

Yes, the stock price drops on official listing. But what gonna happen on first trade after the dividend date, is up to the market. The market is the market, the rules are the rules. I saw prices going up more than once just after the dividend date, exactly because people think will be cheaper. Market doesn't always follow rules.

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Well, the thing there is that the stock might drop by 1% or 2% due to the dividend payout, but it might also rise 2% or even more for unrelated reasons. –  poolie Sep 29 '11 at 0:29
    
@ poolie - exactly to the point. –  H_7 Sep 29 '11 at 0:53

In the case of mutual funds, Net Asset Value (NAV) is the price used to buy and sell shares. NAV is just the value of the underlying assets (which are in turn valued by their underlying holdings and future earnings). So if a fund hands out a billion dollars, it stands to reason their NAV*shares (market cap?) is a billion dollars less. Shareholder's net worth is equal in either scenario, but after the dividend is paid they are more liquid. For people who need investment income to live on, dividends are a cheap way to hold stocks and get regular payments, versus having to sell part of your portfolio every month.

But for people who want to hold their investment in the market for a long long time, dividends only increase the rate at which you have to buy. For mutual funds this isn't a problem: you buy the funds and tell them to reinvest for free. So because of that, it's a prohibited practice to "sell" dividends to clients.

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Share prices fall when dividends are paid out because the paid dividend (cash out) actually reduces the value of the company. Usually the share price falls by the amount of the dividend payment.

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I would say that the answer is yes. Investors may move on purchasing a stock as a result of news that a stock is set to pay out their dividend.

It would be interesting to analyze the trend based on a company's dividend payouts over 10 or so years to see what/how this impacts the market value of a given company.

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Hi @Ren, welcome to the site. Can you back up this answer with some evidence or experience? –  C. Ross Oct 9 '12 at 13:39

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