Aug 30, 2017
How Dividends Affect ETF and Stock Prices
You probably know what a dividend is and you may even have the Stash investment Delicious Dividends in your portfolio. But do you know why companies issue them, and how they affect a company’s share price?
A dividend is nothing more than a sum of cash, typically paid quarterly to people who own stock in a business. Money is paid out to you just for owning the share or stock of a company.
The amount and timing of the dividend payment is decided by the board of directors, a group of people who represent the best interests of the company and its shareholders.
Payment of a dividend usually affects stock prices because control of the money used for the dividend is transferred to the company’s shareholders, meaning money out of the hands of the company and into the hands of the investors.
When a cash dividend is paid, the company no longer controls that amount of cash, which tends to make the company’s stock price drop in the short run. Theoretically, an investor would prefer to own a stock that will pay a dividend compared to that same stock without the right to get that same upcoming dividend.
Keep in mind there is no guarantee that companies that can issue dividends will declare, continue to pay or increase dividends.
How are ETFs Affected by Dividends?
Exchange-traded funds, or ETFs, are baskets of stocks that provide diversification for investors who want to own shares of companies in particular sectors and industries, as opposed to owning single stocks. They make up the vast majority of the investments available on Stash.
As dividends can affect a company’s stock price, it’s possible for dividend payments from companies whose stocks are contained in an ETF to affect the fund’s share price, depending on the weighting of the stock within the ETF. So, if one company experiences trouble and cuts back or stops its dividend unexpectedly, that could affect the price of the ETF.
Let’s break this down with some important dates and examples.
The Dates: Declaration, Ex-Dividend, Record, and Payment Date.
Not all companies pay cash dividends, but the ones that do follow a standard procedure.
1. Declaration Date
A declaration date is the date when the company announces it will pay the dividend, how much it will pay, and the last day a holder of the stock is eligible to receive the dividend if they continue to hold the company’s stock.
A company’s stock depends in large part on market expectations and forecasts. So, if the amount a company says it will pay as a cash dividend on the declaration date follows the expectations, the company’s stock price might not move.
On the other hand, if the company unexpectedly announces a reduction in its dividend, market sentiment about the company may shift. And the stock price could increase or decrease, depending on whether analysts deem the cut a good move or a bad one.
In fact, after many years of paying a dividend, if a company were to suddenly declare that it plans to stop paying a dividend, the market could take this as a bad sign, and could likely push the share price down. This happened to home shopping company Tesco in August of 2014 when it unexpectedly cut its dividend by 75% (ouch!), and issued a warning that its profits would be less than forecast. The company’s stock dropped nearly 8% following the announcement (double ouch).
One important thing to note: If you buy stock on a company’s declaration date, you’ll receive the dividend referenced in the date.
2. Ex-dividend Date
One of the things announced on the declaration date is the ex-dividend date. The ex-dividend date is pretty much what it sounds like: it’s the day after which you can no longer purchase the stock and receive the upcoming dividend.
If you purchase the stock on the ex-dividend date, you will not receive the dividend promised on the declaration date and you will have to wait until the next declaration date to know how much the dividend will be, and when you’ll receive it.
On the ex-dividend date, it is often common for a company’s stock price to drop by an amount equivalent to the amount of cash paid out by the dividend. That’s because investors who buy the stock on the ex-dividend date won’t receive the upcoming dividend. However, if the same investors had bought the stock the day before, they would have received the dividend and the stock price would probably have been higher.
Here’s an example:
Sources: Seeking Alpha and Google Finance
New Residential Investment Corp, a real estate investment company that commonly pays dividends, declared a dividend of $.48 cents with an ex-dividend date on March 23, 2017. Notice how the day before the ex-dividend date the stock price closed at $17.09. By the time the market opened the following day, the company’s share price decreased to $16.65.
Why did it go down $.44 and not the full $.48 cents?
Dividends are only one factor that can affect a company’s stock price. The big drop in New Residential’s stock price followed its ex-dividend date, but numerous other market forces can also affect stock prices. So the magnitude of the drop can’t only be attributed to a dividend payment.
3. Record & Payment Date
The are two additional days related to dividend payments: the record date and the payment date. While it’s important to be aware of them, they are generally more administrative and usually have little or no impact on the stock price.
The record date is simply the date the company looks at its records to see which shareholders are eligible for the dividend, (very important for the company, less important for you, the shareholder). Think of it as the date the company determines who bought the stock prior to the ex-dividend date. It is usually one to four business days following the ex-dividend date.
The payment date is the actual date that checks or electronic payments are sent out to investors eligible for the dividend. If you invest with Stash you probably don’t need to keep track of this date because we send you an email to let you know you’ve received a dividend and how much it is.
If you’ve got dividends on the brain and would like to learn more, check out Stash’s investment with a history of high dividend payments to shareholders: Delicious Dividends.
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