How Do Dividends Affect Stock Price?

If you invest in dividend-paying stocks, knowing how they behave around dividend payment dates can help you time your buys and sells better to maximize your returns or avoid common pitfalls. Depending on the type and size of dividend, its effect on the stock price can last several days or indicate a change in a long-term trend.

Ex-Dividend Date

Once a corporation declares a dividend, the stock is said to trade “with the dividend.” If you buy the stock, you will get the dividend. The ex-dividend date is the first day the stock trades without the dividend. If you buy the stock on or after that date, you will not get the dividend, which will be paid to the previous owner — the seller you bought the stock from. On the ex-dividend date, the stock price drops by the amount of the dividend, but gradually drifts back to its old level over the next several days.

Stock Dividend

A corporation can pay a dividend in company stock. The most widely used is a 100-percent dividend, commonly known as a 2-for-1 stock split, when an investor receives one new share of stock for each one he owns. When a stock split goes through, the stock price is adjusted inversely. For example, if you owned 100 shares of XYZ at $50 before the split, you will now own 200 shares of XYZ at $25.

A stock split can have longer-term implications for the stock price. The first stock split usually excites investors, who bid the stock price higher. A company splits its stock when the price has risen because it has done well, so a stock split is perceived as confirmation that things are looking great and the stock is a good buy. On the other hand, excessive stock splits, such as several 2-for-1 splits over a short period or a 5-for-1 split, often indicate that the price has risen too far and the stock may soon go into decline.

Special Dividend

A company may come into an unusually large amount of cash either through the sale of a subsidiary or a court settlement. It may decide to distribute the cash to the shareholders as a special one-time dividend. If the dividend is large enough relative to the size of the company, the stock price will be adjusted permanently. For example, XYZ, which is currently at $10 a share, declares a special $5 dividend. The good news may send the stock price higher — some investors may simply want to buy it to get the cash. Once the stock goes ex-dividend, the price will drop by $5 and the adjustment will be permanent.

Long-Term Effects

Earnings are the primary factor that affects stock prices. Since dividends are paid out of earnings, dividends have little long-term effect on stock prices, because earnings are factored into the stock price long before dividends are paid. Dividends also smooth out price fluctuations; dividend-paying stocks typically fluctuate less than stocks that do not pay dividends.

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