Many individuals often choose to invest in securities available in the stock market to ensure a steady flow of returns through periodic dividend pay-outs. Such earnings can be utilized for reinvestment in the stock market, or to meet any personal requirements of investors.
Nonetheless, the dividend pay-out facility is extended to shareholders at the discretion of a company, who might choose to distribute total profits earned in one financial year or reinvest it. But ever wondered how dividends paid by a company impact its stock prices? Is there a correlation and if yes, then what? Let’s find out.
First Things First : How Can You Earn Dividends?
Respective companies can undertake dividend pay-outs in two primary ways – cash dividends and stock dividends. As the name suggests, monetary funds are transferred to the accounts of shareholders in case of cash dividend disbursal.
In the case of stock dividends, on the other hand, additional shares up to the value of such eligible dividend amount are issued in the name of all existing shareholders. Profits from such stock dividends can be realized through cash dividends in the upcoming years or through capital gains upon resale in the future.
How Does It Affect Prevailing Stock Prices?
Companies declaring dividend pay-outs annually , often gain the confidence of investors, as they believe that the business is performing well, and poses as a reliable investment venture. As a result, the share price of such companies is often high in the market, owing to its high-demand among risk-averse individuals, looking for stable investment ventures.
Conversely, companies choosing to retain their annual earnings for business development purposes fail to incite investors, as investors often develop a mind-set that, such businesses might have under performed or incurred losses for a particular year.
Companies undertaking erratic dividend pay-outs often face a similar consequence, as individuals look at such investment ventures to be extremely risky. Consequently, shares of such companies frequently trade at a relatively lower price in the market.
What Are The Long Term Effects?
Usually, large-cap companies manage to establish a fair market reputation through timely dividend payments of substantial amounts to all respective shareholders. It is a major contributing factor to the high share prices of such business ventures. On the other hand, small and mid-cap companies often choose to retain their profits for an extended period to increase their productive capacity, which, in turn, labels underlying equity shares as non-profitable investment ventures.
As a result, stocks of such small and mid-scale businesses often trade at a relatively lower price. If you are looking to acquire an equity stake with the primary goal of extensive dividend earnings, it could prove fruitful to stick to the stocks of large-cap and blue-chip companies.
The effects of timely payments of dividends reflect on long-term fluctuations in the stock prices. Short-term variations occur within a time span of 2 – 3 days, between the dividend declaration and ex-dividend date.
Confused? Let’s Take A Closer Look.
While talking about dividend pay-outs, there are three dates you need to know about.
Firstly, the dividend declaration date, which is the date on which a company announces the proportion of profits to be distributed to all shareholders as dividends in a press release.
Second is the record date when a business goes through its books to determine all shareholders eligible to receive such dividend profits.
Last the distribution date when all funds are disbursed to the accounts of respective shareholders having an equity stake in such company.
When a company announces that it will roll out dividend pay-outs for a stipulated year, it is often noted that the stock prices are on a rise. Such an increase can be attributed to the fact that many individuals often look into purchasing shares in the hopes of receiving dividend yields, even at a premium cost.
Such fluctuations persist till the ex-dividend date, which is technically three business days before the record date.
The significance of this date is that any individual purchasing stocks on or after this date are not eligible to receive dividend pay-outs for that respective financial year, as it takes a minimum of three days to record the name of a shareholder in the books of a company.
As a result, a downtrend in the stock price is often observed as investors are reluctant to purchase such shares at a premium. Stock prices are likely to adjust post the ex-dividend date, as investors are not that eager to acquire shares of respective companies henceforth.
Hence, if you are looking for stock market investment ventures just to earn dividends, you should look out for declaration dates of major companies listed in the stock market and should purchase shares before the ex-dividend date.
Is That All?
Another aspect to consider while understanding the effect of dividends on share prices is stock dividends.
A similar effect is demonstrated by the issuance of stock dividends in the market, wherein post the declaration date, a surge in the stock prices can be witnessed in the market, as investors are willing to pay a higher price for each respective share to earn stock dividends.
Such an increase in the share price automatically adjusts as the demand falls immediately prior to the ex-dividend date, as individuals purchasing shares on or after the ex-dividend date will not receive stock dividend benefits.
Nonetheless, the long-term performance of stock prices remains high for companies listing out stock dividends periodically as a reward for its shareholders, as it is an indicator of good performance and high annual profits without any significant fluctuations.
Such variations in the stock prices can be classified as systematic fluctuations, owing to dividend announcements made by companies. Having a general idea about the same will help you understand the reason behind any such stock price variations, and thereby, analyse the credibility of a corresponding investment.
I hope, now, the impact of dividends on stock prices might be clear to you to some extent. Check out the Groww YouTube channel for more knowledge packed videos on investing and pressing matters of the financial world .
Disclaimer: The views expressed in this post are that of the author and not those of Groww.