While dividend stock investing is usually a relatively simple strategy, there can be some complexities associated with the timing of payments. Specifically, the mechanics of the ex-dividend date can be confusing.
Ex-Dividend 101
There are three key dates associated with a dividend payment:
- Declaration Date: A company announced that it will pay a cash dividend at some point in the future.
- Ex-Dividend Date: Beginning on this date, an investor who purchases shares of the stock will not receive the upcoming dividend; the dividend goes to the seller instead.
- Payment Date: The cash dividend is received by the shareholder of record — defined as the owner of the stock on or before the ex-dividend date.
Investors who own shares of a stock at the close of trading before the ex-dividend date will receive the upcoming distribution. Those who purchase shares after the opening bell on the ex-dividend date won’t receive the next dividend. It’s that simple.
A stock’s value can be thought of as the sum of all future cash flows expected to be received, discounted to their future value. On the ex-dividend date, one such cash flow is effectively separated from the others.
Shares purchased before the ex-dividend date entitle the owner to all future cash flows. Shares purchased on the ex-dividend date are no longer entitled to the next cash flow (the green area in the figure above), but they do have a claim on all subsequent (yellow) distributions.
As a result, ex-dividend shares are worth less than they were the day before and the share price typically drops by the amount of the relevant dividend. In reality, the separation of this dividend is only one of the many factors that influences a stock’s price on any given day; shares will rarely change by the exact amount of the distribution.
AT&T Example
Consider the following example of AT&T’s 2015 dividend. The following information was released ahead of the distribution:
AT&T Inc. (T) will begin trading ex-dividend on July 08, 2015. A cash dividend payment of $0.47 per share is scheduled to be paid on August 03, 2015.
In this situation, any investors holding shares of T at the close of trading on July 7 will receive a distribution of $0.47 per share on August 3. Those purchasing shares on July 8 or later would not receive the dividend in August — even if they still held the shares on the date that the checks went out.
News articles and press releases typically mention that a stock “will begin trading ex-dividend” on a certain date. This means that any shares purchased on that date will not receive the upcoming dividend; once a stock has “gone ex-dividend” the window to receive the distribution has passed.
Trading Ahead of Ex-Dividend Date
Some investors practice “dividend capture” strategies that involve buying a stock the day before its ex-dividend date (or earlier) and selling it on the ex-dividend date (or later). These investors would receive the cash dividend on the subsequent payment date.
While it may sound appealing, dividend capture strategies won’t generate excess returns when markets are efficient. Because the price of a stock is expected to drop by the dividend amount on the ex-dividend date, this strategy will (all else being equal) see investors sell at a loss equal to the dividend received.
Other drawbacks of a dividend capture strategy include:
- Trading commissions are incurred to both open and close a position; and
- Typically, the investor would be ineligible for qualified dividend tax rates as a result of not holding stock for at least 60 days.
Ex-dividend dates can potentially impact limit orders as well. Suppose that a stock:
- Closes at $50.00 on July 7;
- Will pay a dividend of $2.00 per share on August 3; and
- Begins trading ex-dividend on July 8.
Further, assume you have a limit buy order at $48.00. Assuming no other factors impact the price, the stock would be expected to open trading at $48.00 on July 8.
Typically, brokerages will automatically reduce limit, stop, and stop limit orders by the amount of the relevant dividend; in the example above, the limit buy order would be altered to $46.00.
Ignoring Ex-Dividend Dates
Because markets are generally efficient, investors shouldn’t become too preoccupied with ex-dividend dates. Any declines in value will be offset by a short-term cash flow, and any outstanding orders should be automatically adjusted to reflect the separation of the cash payment from the stock.
Investors focusing on implementing a long-term strategy would be better off ignoring ex-dividend dates altogether, and focusing on identifying attractive buying opportunities.
This article, How to Trade Stocks on Their Ex-Dividend Date, first appeared on Dividend Reference.