8

As per this Investopedia article:

Because the stock price is expected to drop by the amount of the dividend on the ex-dividend date,

Why is a stock expected to fall on the dividend date? Does it mean people that bought the stock just for the dividend will sell as soon as the dividend is paid out, leading to a fall in the price?

  • 2
    Re: "People that bought the stock just for the dividend will sell as soon as the dividend is paid out [...]?" ---> Certainly not! Most people who buy a stock because of the dividend end up holding the stock for a while, and thereby collecting a stream of dividend payments -- often with a goal to generate income from an equity investment portfolio without having to sell a position. – Chris W. Rea Jan 20 '14 at 20:36
  • 3
    This question has received a couple of down-votes. At least as currently written, I think that's unfair. The question shows a lack of understanding of dividends, but an entirely reasonable lack that can easily be explained. If downvoting, please consider explaining why. :) – ChrisInEdmonton Jan 20 '14 at 21:20
9

The stock should fall by approximately the amount of the dividend as that is what is paid out. If you have a stock trading at $10/share and it pays a $1/share dividend, the price should drop to $9 as what was trading before the dividend was paid would be both the dividend and the stock itself.

If the person bought just for the dividend then it would likely be neutral as there isn't anything extra to be gained. Consider if this wasn't the case. Wouldn't one be able to buy a stock a few days before the dividend and sell just after for a nice profit? That doesn't make sense and is the reason for the drop in price. Similarly, if a stock has a split or spin-off there may be changes in the price to reflect that adjustment in value of the company. If I give you 2 nickels for a dime, the overall value is still 10 cents though this would be 2 coins instead of one.

Some charts may show a "Dividend adjusted" price to factor out these transactions so be careful of what prices are quoted.

2

Suppose the price didn't drop on the ex-dividend date. Then people wanting to make a quick return on their money would buy shares the day before, collect the dividend, and then sell them on the ex-dividend date.

But all those people trying to buy on the day before would push the price up, and they would push the price down trying to sell on the date.

2

The stock price is what people think a company is worth, this is made up of

  • Money the company has in the bank.
  • Building and stock the company owns
  • Skills of the staff of the company
  • Goodwill
  • Etc
  • How people expect the above to change over the next few years.

When a company pays out a dividend the money in the company’s bank account reduces, therefore the value of the company reduces.

When a company says they are going to pay a larger dividend than expected, we start to expect they are going to make more profit next year as well.

So stock price tends to go up when a company says it is increasing the dividend, but down on the day then money leaves the companies bank account. There is normally many months between the two events.

-3

This effect has much empirical evidence as googling "dividend price effect evidence" will show.

As the financial economic schools of thought run the gamut so do the theories. One school goes as far to call it a market inefficiency since the earning power thus the value of an equity that's affected is no different or at least not riskier by the percentage of market capitalization paid.

Most papers offer that by the efficient market hypothesis and arbitrage theory, the value of an equity is known by the market at any point in time given by its price, so if an equity pays a dividend, the adjusted price would be efficient since the holder receives no excess of the price instantly before payment as after including the dividend since that dividend information was already discounted so would otherwise produce an arbitrage.

  • 2
    It's not clear what is being said here. Simply put the value of a promise to pay $1 tomorrow is about $1 today and once that payment has happened its value is zero. – Guy Sirton Sep 13 '14 at 20:06
  • Those search terms did not produce any useful evidence. – DJClayworth Dec 22 '15 at 18:19

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