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Dividends are one of the ways companies share their profits with equity shareholders. While dividends are often viewed as a source of regular income, they can also influence how dividends affect stock price. The announcement, payment, and timing of dividends may affect investor sentiment and, in turn, the share price.
This connection between dividends and stock prices is not always straightforward and can vary based on several factors. Understanding how dividends affect stock price movements helps investors better interpret market reactions around dividend-related events.
Key Takeaways
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Dividend announcements and ex-dividend dates can cause short-term price movements.
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Share prices usually adjust on the ex-dividend date to reflect the dividend payout.
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Futures and options prices change indirectly as they track movements in the underlying stock.
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Long-term stock value depends more on company fundamentals than on dividends alone.
The Concept of Dividends
The equity shareholders are technically the owners of a company. And as such, they have a claim to the company's profits. So, when a company generates profits, it distributes them to its equity shareholders as dividends.
When it comes to paying dividends, a company does not always pay them in cash; instead, it can issue new shares to its shareholders for free. Such a dividend payout is commonly referred to as stock dividend (or Bonus Issue in India).
Also Read: What is Shareholder Equity?
Why Should You Invest in Dividend Paying Companies?
Below are a few benefits of investing in companies that pay dividends:
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Acts as a reliable source of passive and stable income
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Opportunity to reinvest the dividend amount
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Offers tax advantages
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Increases the rate of compound gains
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Acts as a hedge against market volatility (defensive investing)
What is the ex-dividend and record date?
There are 4 dates associated with the divided payment, and each has its own significance. However, 2 dates that critically matter are:
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Ex-dividend Date
The date by which investors must own the stock to receive the upcoming dividend. In simple terms, you must purchase the stock before the ex-dividend date to be entitled to the payout. Shares bought on or after the ex-dividend date do not carry dividend entitlement.
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Record Date
It signifies the date on which a company determines the list of shareholders who are eligible to receive the announced dividend payment.
Also Read: What is Ex-Dividend Date?
How Does Dividend Affect Share Price?
Now that you’re aware of the dividend concept, let’s move on to answering the question ‘how do dividends affect stock price?’ Paying dividends is a strong indicator of a company’s financial health and success. That said, here are some pointers that clearly show how dividends affect stock prices:
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Dividend-paying companies enjoy favourable treatment
Many well-established companies have made it a habit to regularly distribute the profits they generate. This demonstrates their stability and enhances the company's goodwill and brand value. Investors tend to view such entities in a far more favourable manner than other entities that don’t distribute dividends as often.
This consistent dividend-paying mechanism tends to attract even more investors, thereby creating demand for the stock. As more and more investors flock to the company, the share price rises.
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Dividend declaration may lead to an increase in the share price
A company, before distributing the dividend to its shareholders, first makes a public declaration. This declaration includes essential details such as the dividend amount, the record date, the ex-dividend date, and the date on which the dividend is likely to be credited to all the equity shareholders of the company.
Such a public declaration has a high probability of positively affecting public sentiment toward the company’s stock. As a result, more investors may purchase the stock, which in turn may increase the share price. In addition, many traders and investors may buy the company's stock for the short term to capture the company's dividend. Such a move would also help increase the price of the dividend-issuing company’s stock.
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The share price drops on the ex-dividend date
Continuing from the previous point, if the share price rose after the company declared the dividend, it would automatically correct itself on the ex-dividend date. This may be because any new buyers of the company’s stock on or after the ex-dividend date would automatically become ineligible to receive dividends.
As new buyers won’t be eligible to receive dividends, they might not be willing to pay a high premium for the shares, so they might start quoting lower prices. This might prompt sellers to demand lower prices, potentially negatively affecting the company’s stock price.
Also Read: What is Dividend Investing?
Impact of Dividend on Futures & Options Contracts
Many investors believe that the holders of futures and options contracts do not receive any dividends, and they shouldn’t worry about their impact on futures and options prices. However, the truth is that dividend payments indirectly impact the prices of futures and options contracts.
For instance, if the company announces a dividend of Rs. 10, its stock price will decrease by the same amount on the ex-dividend date, thereby adjusting the price to absorb the impact of the dividend. This is because share prices directly affect the prices of derivatives (futures and options), as they are priced based on their underlying asset.
Ordinary dividends (less than 2% of market value) - The exchange does not explicitly adjust prices for ordinary dividends, futures, or options. However, on the ex-dividend date, the stock price normally declines by about the dividend amount, which indirectly affects F&O premiums.
Extraordinary Dividends (≥ 2% of Market Value) - Updated SEBI Rule - Previously, dividends exceeding 5% of a stock's market value were deemed extraordinary. Under the new SEBI framework, any dividend distribution exceeding 2% of the underlying stock's market value is considered an extraordinary dividend.
Under extraordinary dividends, the following modifications apply:
1. Futures contracts: The futures contract's base price is decreased by the dividend amount on the ex-dividend date.
2. Option Contracts: The dividend amount reduces the strike price of an option contract. Generally, the lot size remains constant during such modifications.
These changes guarantee that F&O contract values remain reasonable following a major dividend-related price effect.
What are the long-term effects?
Over the long term, dividends do not directly change the core value of a company’s share price. Companies in a growth phase often retain profits to fund expansion, while established companies may distribute profits as dividends. This difference reflects business strategy rather than performance quality.
Share prices are mainly influenced by future earnings potential, business stability, and market expectations. Dividends may support investor confidence over time, but long-term stock value is driven more by fundamentals than by dividend payouts alone.
Assessing the Impact of Small Dividends on Stock and Option Prices
Small dividend payouts usually have a limited and short-lived impact on stock prices. On the ex-dividend date, the share price may adjust by an amount close to the dividend value, but this change is often minor compared to normal daily price movements.
In many cases, market demand, trading volume, and broader conditions play a larger role than the dividend itself. For derivative contracts, small dividends may lead to slight price adjustments, but these are generally absorbed quickly and may not significantly influence overall trading behaviour.
Conclusion
The above-mentioned pointers help you understand ‘how does dividend affect share price?’ and ‘impact of dividend on the futures and options contracts.’ As an investor, you must know that investing in companies that pay dividends has various benefits, such as stable income, tax advantages, and more.
However, as mentioned earlier, the smart way to invest in any company is to research thoroughly about fundamentals, vision, mission, past performance, and more before making your investment decision.
Also Read: What is Futures & Options (F&O)
