How Dividend Affects Stock Prices?
By: Ganesh Adhikari
Publicly listed companies pay dividends to distribute the profits earned over a specific period to shareholders. Dividends are passive income opportunities for investors.
The share price represents the future cash flows and constitutes the future dividends streams. Thus share price drops after the book closure of dividend distribution. Dividends can either be paid in cash or in the form of additional shares (bonus). The amount of cash or bonus dividend received by the investor depends on the number of shares owned by him/her.
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Stocks paying high and regular dividends are the favorites among investors. Thus it would be no surprise that a stock that pays regular high dividends will have a high price. Those companies which have consistent dividend history are considered financially stable ones. These types of companies are often categorized as buy and hold companies and preferred as good investment options.
Effect of Dividend Declaration
Before distributing the dividends the company must first declare the dividend amount and the book closure date. The ex-dividend date or the book closure date is the date that a shareholder must hold his/her stocks to receive the dividends. Those who buy the shares after the book closure date are not entitled to dividends.
Some investors may only buy shares to collect the dividends of some companies and sell after the ex-dividend date to earn profits.
Stock Dividends
After the declaration of dividends, the stock price usually increases. The stock dividend doesn’t change the company’s value but only the outstanding shares are increased. This dilutes the book value per share and thus the stock price is adjusted after the stock dividend is distributed.
If a company whose shares are trading at Rs. 1000 distributes 20% stock dividends. the share price will be adjusted to Rs.833.33 after the ex-dividend date. For a company whose shares are trading at Rs. 1200 that distributes 25% stock dividend, the share price is adjusted to Rs. 960 after the ex-dividend date.
Adjusted price = Market Price Before Ex-Dividend Date/(1+Bonus Share %)
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Dividend Payout Ratio and a Dividend Yield Ratio
The dividend yield ratio is important for investors to evaluate the returns per share owned by the investor. It is calculated by dividing the dividend distributed per share by the market price and multiplying by 100.
Dividend yield = (Annual Dividend Per Share/Market Price Per Share) *100
The dividend yield ratio helps the investors to compare the dividend income for his or her portfolio or holdings to other stock’s dividend income that provides high and stable dividend income.
The dividend payout ratio is used to determine the company’s financial condition and the ability of the company to maintain or improve its dividend payout. A dividend payout ratio shows the net income distributed by the company in the form of dividends.
DPR =Total Dividend/Net Income
Bottom-line
The dividend is an important element of investing. Dividends investing can become a good passive source of income. The fluctuations in prices before and after the ex-dividend date can be exploited to gain profits by short-term traders and long-term investors can benefit from the dividends distributed by the company.
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