RE: Alert - Dividend15 May 2021 09:45
In a nutshell, stock prices fall after dividend is paid because the company is utilizing a part of its reserves and cash balance to pay out the dividends, and also dividend distribution tax that has to be paid with it. As a result, the company’s cash and accumulated profits shrink to the extent of dividend outflow.
However, there is more to it.
Dividend is declared in the company’s Board meeting (generally on the day of Annual/Quarterly results). A future record date is set, all the shareholders on this record date are entitled to dividends. Given that this record date is in the future and not in the past, the market can buy the shares of the company such that they become share holders of the company by the record date (this is subject to T+2 rule, i.e. the trade must be concluded atleast 2 days prior to the record date).
As you can see, when the dividend is declared by the Board, the buying activity will increase, thus pushing up the stock price (assuming all else being equal).
After the record date, the buyers who had purchased the stock solely for receiving dividend will now sell the stock. Even if the dividend would be paid on the future date, the payment will be made based on the shareholder’s list on the record date. Hence, it doesn’t matter whether one is a shareholder on the date of dividend payment or not.
At this point (i.e. after the record date) the price will tend to fall (Again, this is assuming that all other factors being equal).
In reality, there are many other factors in play, and it is difficult (although not impossible) to isolate the impact due to dividends - for instance, the price could also go up if the results declared are better than expectation and vice-versa. Furthermore, there are certain companies which pay dividends consistently, and the expectation of this would be already priced in by the market. In such cases, the prices wouldn’t drop even after record date/dividends payment since it is likely that they will pay dividends again in the near future.
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