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Understanding How Dividend Payments affect Stock Prices

equity market
09 Sep 20246 mins readBy MOFSL

Investing in the stock market can be a rewarding journey if you put your money in the right companies. Investing in a fundamentally strong company not only helps to appreciate your capital but can also offer a stream of passive income in the form of dividends.

Dividends are a common way that companies use to make a profit payout to their shareholders. Dividends are paid out on a per-share basis.

If ABC company announces a dividend of Rs 20 per share, you would earn Rs 20 for each share you own. If you own 100 shares of ABC, your total dividend income would be 100 * 20 = Rs 2000. Dividends are directly deposited into your bank account linked to your Demat account.

Dividends are often expressed as a percentage of the share's face value. In ABC's case, with a face value of Rs 10 and a dividend of Rs 20, the dividend payout is 200% (20/10).

However, companies are not obligated to pay dividends every year. Many companies use their cash reserves to fund new projects. So, they choose to reinvest profits instead of distributing them as dividends. This is common in younger companies that prefer to reinvest earnings for further expansion.

As a company’s growth slows and it accumulates excess cash, it might choose to reward shareholders with dividends. In such cases, distributing cash to shareholders is often more beneficial than retaining it on the company’s balance sheet. This consistency signals the company’s stability, reputation and brand value.

Investors tend to view these companies more favourably compared to those that do not distribute dividends as frequently.

The regular payment of dividends often attracts more investors, increasing demand for the stock and, consequently, driving up the share price. Dividends can also be paid from the company's cash reserves, even if the company has reported a loss for the year.

The decision to pay dividends is made by the company's board of directors during the Annual General Meeting. Dividends are not paid immediately after the announcement, as the company needs to determine which shareholders are eligible.

The timeline below explains the dividend cycle:

1. Dividend Declaration Date: The date when the AGM takes place and the board declares a dividend.

2. Record Date: The date on which the company reviews its shareholder register to determine who is eligible for the dividend. This is normally 30 days after the dividend declaration date.

3. Ex-Date/Ex-Dividend Date: This date usually coincides with the record date due to the T+1 settlement cycle in India. Only shareholders who own the shares before this date are entitled to receive the dividend. To ensure you receive the dividend, you must purchase the shares before the ex-dividend date. 

4. Dividend Payout Date: The day when the dividend is distributed to eligible shareholders.

Dividend announcements positively influence public sentiment. This leads more investors to buy the stock, which may result in a rise in the share price. Many traders and investors purchase the stock in the short term to qualify for the dividend.

When a stock goes ex-dividend, its price drops by the amount of the dividend paid. For instance, if ABC is trading at Rs 250 and declares a dividend of Rs 20, the stock price might drop to Rs 230 on the ex-date.

This price drop occurs because the dividend amount is no longer part of the company’s balance sheet, so the stock price adjusts accordingly.

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However, the price drop isn't always noticeable.

A company may issue a special dividend, which is a one-time, larger-than-usual payment. When a special dividend is paid, the stock price often drops significantly.

This price drop should not be seen as negative, as shareholders receive a cash payment.

Conclusion

As an investor, there are many benefits of investing in dividend-paying companies. This means having a steady passive income stream and tax benefits.

However, the key to making a smart investment is to thoroughly research a company’s fundamentals, vision, mission, past performance, and other relevant factors before deciding to invest.

 

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Disclaimer: The stocks, companies, or financial instruments mentioned in this blog are for informational purposes only and should not be considered as investment recommendations. It is advised to consult with your financial advisor before making any investment decisions. Investment in securities markets are subject to market risks, read all the related documents carefully before investing. Investors are strongly encouraged to carefully read the risk disclosure documents prior to participating in market-related investments or trading activities. Due to the volatile nature of financial markets, no guarantees can be made regarding investment returns. Motilal Oswal Financial Services Ltd. does not offer any assured returns on market-linked securities. Please note that past performance of stocks or indices is not indicative of future results.
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