Who wouldn’t like some extra payout now and then? If you are one of those traders who have their investment strategy based on good income generation, you might have to look for the shares of those companies, which issue dividends. But before one goes ahead and makes a pick for the investment, it is also important to know as to how the dividends would fit into one’s portfolio and how they matter to the stock market trading.
Most of the investors who have their interest in dividends always have a similar question, i.e. how dividends affect stock prices? To understand the answer for this, one should know the major difference between the expected as well as the unexpected changes in price.
Let us now have a look at 5 ways company dividends affect share price:
1. Discover the stock’s share price
The prices of the shares fluctuate every second in stock markets and this makes it hard for the experts to know the right price to purchase the stocks. Trade analysts make use of various models to identify the right price of the share. One of such methods is based entirely on dividends. This method says that the right price of the share is the present value of all those future dividends. So, if the dividends are higher, one can expect an increase in the share price too. However, in India, a number of companies also reinvest the profits for business growth and thus they only give out a small portion of their profits as dividends to their investors.
2. The Ex-dividend price
The prices of the shares normally see a rise when the company is about to announce the dividends. Once the dividends are distributed, the share price plummets immediately. In many cases this fall in the share price is almost equal to the dividend that has been announced. For example, if a company X has distributed the dividends worth Rs. 50, one can most likely expect a fall in the stock price by the same amount one day after the distribution has been done. This price is called as the ex-dividend price.
3. The Dividend rally
It is a well-known fact that not every trader follows the same strategy to make money in stock markets. While there are some who buy the shares and hold on to them for many years, there are others who prefer day trading or hold their stocks short term to make some quick bucks. One of such strategies used by traders to earn quick is to make the best use of dividend rally. Traders thus buy the shares atleast a month before the dividend is announced. The news of dividend being announced increases the price of the stock. Once the dividend is distributed, the traders then sell the shares and earn good profits. This is just another way on how dividend affects the prices of the shares.
4. The Dividend yield
While the above-mentioned are some of those factors and strategies, which show how dividends affect the stock prices, there is also another strategy, which is used by many investors. These traders invest only in those companies, which announce good dividends and they also keep in mind the price of the share of that company. They compare the dividends by using Dividend yield. One can get the dividend yield by dividing dividend amount and the share price and the result is multiplied by 100.
5. The change of stock prices on the dividend day
Whenever a company declares the dividend, the amount can be either higher or lower than expected. This can show a huge impact on the price of the stock and it can fluctuate based on the declaration made. We can take an example of two scenarios here:
Dividend announced is lower than expected: When a company XYZ announces the divided, which is lower than what was expected, it can cause a drop in the stock price and even the investors start to speculate the reasons for the same.
Dividend announced is higher than expected: When such a scenario occurs, the market sentiment of the company will certainly cause an increase in the stock price and even the investors wonder if the company is seeing a substantial growth.
Now that you as an investor know the affect of dividend on the stock prices, it is time you invest in the right stocks to earn smartly.