If a stock price goes down on the ex-dividend date by the amount of the dividend, what’s the benefit of a dividend? It seems like you don’t gain anything.
I chose this question because it’s a bit of an investing brain teaser. And I love brain teasers – almost as much as I love dividends.
Before I answer the question, let’s review what the various dividend dates mean. We’ll use BCE Inc. (BCE) as an example. (Disclosure: I own the shares.)
On May 2, BCE declared a quarterly dividend of 75.5 cents on its common shares. The dividend is payable on July 15 to shareholders of record on June 15.
The declaration and payment dates are straightforward enough, but the record date requires an explanation. Because it takes two business days for a stock trade to settle, if you want to be a shareholder of record on June 15 – and be entitled to receive the dividend – you’ll have to buy the shares on June 13 or earlier.
If you wait until June 14 – the day before the record date – to buy, you won’t get the next dividend. That’s why it’s called the ex-dividend date.
However, you won’t actually lose anything because – all else being equal – the stock price will fall on the ex-dividend date to reflect the fact that the dividend is no longer part of the deal. So you’ll get to buy the shares at a discount. (In practice, a stock rarely drops by the exact amount of the dividend because there are lots of other factors at play.)
Similarly, you won’t gain anything by buying, say, a day before the ex-dividend date. In that case you would receive the dividend, but you’d have to pay a higher price – again, all else being equal – and your shares would drop in value on the ex-dividend date.
So, getting back to the reader’s question, if nobody wins or loses by buying (or selling) on, before or after the ex-dividend date, what is the value of a dividend? Isn’t everybody right back where they started?
Well, yes, but only if you’re looking at a very short time frame. All that’s happening here is that the market is adjusting the stock price to account for whether the dividend is included in the transaction. To understand the true value of a dividend, you need to step back and consider where the dividend came from in the first place.
Dividends are paid out of the aftertax earnings of a company. When you receive a dividend, you are getting a share of the profits, and those profits are accruing day after day, month after month and quarter after quarter. When the ex-dividend date comes around, the stock price will drop briefly, but it will rise again as more earnings roll in to pay even more dividends.
If a company’s earnings are growing steadily, the dividend – and the share price – should also grow. So, as much as a dividend may seem like a zero-sum game in the short run, over the long run it represents a tangible way for investors to share in the profits of a business.
Now, some companies don’t pay dividends at all. Maybe they’re not profitable yet, or their businesses are too cyclical to support a dividend, or they prefer to reinvest all of their earnings internally to expand the business. Growth-oriented companies such as Facebook, Amazon, Alphabet, and Netflix, for instance, have never paid a dividend, but their share prices have crushed the returns of many dividend stocks.
But say you wanted to put some of Facebook’s or Amazon’s gains into your pocket to pay for living expenses or simply to invest elsewhere? You’d have to sell some of your holdings, which means paying brokerage commissions and, possibly, capital-gains tax. No big deal, perhaps, but with a dividend-paying stock, you don’t have to lift a finger: The company automatically sends you cash (which, if you’re investing in a non-registered account, is taxable) every quarter or every month. The passive nature of dividend investing is one of the reasons it appeals to people, like me, who enjoy getting a stream of cash. (I also get exposure to growth stocks through various exchange-traded funds.)
Another benefit of dividend investing is that it helps investors choose stable companies and avoid speculative ones. If you’ve read my Yield Hog columns, you’ll know that I am especially fond of companies that raise their dividends regularly, because this is often a sign of a strong business. With any investment, it’s important to focus on the long term – something to remember the next time one of your stocks drops on the ex-dividend date.