Dividends

A dividend is a payment a company makes to its shareholders, usually in cash, as a share of its profits. Mature, profitable companies often pay regular dividends, while fast growing companies may pay nothing and reinvest instead. Dividends provide income, signal management's confidence and affect share prices, option values and trading strategies. Understanding how dividends work, especially the key dates, avoids common mistakes.

Key dividend dates#

With US stocks settling one business day after the trade (T+1, since May 2024), the ex dividend date is usually the same as the record date. To receive the dividend, you must buy before the ex dividend date.

Types of dividends#

Dividend policy#

Companies set dividends based on earnings, cash flow, growth opportunities and financial strength. Many follow a stable policy, raising dividends gradually and avoiding cuts, because cuts often send a strong negative signal. John Lintner's 1956 study found that managers smooth dividends over time and adjust slowly toward a target payout ratio. See Capital Allocation and Management.

Dividends and share prices#

• Ex dividend drop: prices fall by roughly the dividend amount on the ex date.
• Signalling: initiations and increases tend to be received positively; cuts negatively.
• Total return: dividends are a large part of long term stock market returns. Reinvested dividends have accounted for a substantial share of the S&P 500's total return over long periods. See Measuring Returns and CAGR.

Dividends and options#

Dividends affect option prices and early exercise:

• Call prices are lower when large dividends are expected; put prices are higher.
• Early exercise of American calls can make sense just before an ex dividend date. See Early Exercise.
• Short call holders face assignment risk before ex dates.

Dividends and backtesting#

Price data that is not adjusted for dividends understates returns and creates false drops on ex dates. Backtests should use total return or adjusted prices. See Corporate Actions, Delistings and Rolls in Backtests and Splits and Dividends in Price Data.

Taxes#

Tax treatment varies by country. In the US, "qualified" dividends are taxed at lower long term capital gains rates if holding period rules are met; others are taxed as ordinary income. Many countries withhold taxes on dividends paid to foreign investors. See Trading Taxes and Capital Gains.

Dividends vs buybacks#

Both return cash to shareholders. Dividends give regular income; buybacks are more flexible and may be more tax efficient in some places. See Buybacks and Free Cash Flow Yield and Dividend Yield.

Frequently asked questions#

What is the ex dividend date?#

The first day a stock trades without the right to receive the upcoming dividend; you must own the shares before this date to get paid.

Does a stock price drop after a dividend?#

Typically, yes. On the ex dividend date, the price usually falls by roughly the dividend amount, all else equal.

Why do companies pay dividends?#

To return cash to shareholders, signal confidence in future earnings and attract income focused investors.

Next, learn what happens when shares are divided in Stock Splits.