Episode 70: October 13, 2010
Stocks, Options & Warrants
by Andrew Horowitz
We received a great and common question many investors ask about the mechanics of receiving an actual dividend payment-- namely how and when do you have to own a stock to collect a dividend and how does it work?
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How to Collect a Dividend
Listener Brian asks "When is the first opportunity I can sell a stock I own and still collect the dividend payment?"
His question relates to a recent event with stock MedQuist (MEDQ) which announced a special dividend payment with the date of record on October 11, 2010. Brian wants to know if he can sell the stock at some point on October 11th and still receive the dividend, or if he has to wait all the way to the next morning on October 12th to sell the stock.
First, let us make the question easier and assume Brian owned the stock prior to October 11th and was holding on just to get the dividend. We'll talk about buying ahead of a dividend soon, but to answer Brian's question quickly, let's just assume he was an owner of MedQuest when they announced their special dividend.
The short answer is that he would need to own the stock on the close of the business day on the record day, October 11th, and would collect the dividend payment as long as he held shares as of close on October 11th. Selling ahead of the October 11th close would mean he was not a shareholder on the close of the business day, and would not receive a dividend payment.
Now that we have the simple answer, let's define a few terms and explain the logic of how to receive a stock dividend.
Why Do Companies Pay Dividends?
Companies pay dividends to shareholders as a "thank you" for owning the stock; dividends are seen as a company’s way to share their profits with their investors. Shareholders own fractional ownership of a company, and often receive a portion of quarterly profits through dividends, though not all stocks offer dividends to investors. Growth stocks and technology stocks often do not provide dividends to shareholders, whereas large established companies often do provide dividends.
An annual dividend yield, which is the percentage of money of the share price an investor receives, is typically 2% to 4% of the price of a share of stock. So, on a stock worth $50 per share, a reasonable dividend yield would be around $1.00, which would be about a 2% dividend yield. That's quoted in annual terms, so each quarter--or three-month--dividend would be 25 cents, or about one-half of a percent.
When Do Companies Pay Dividends?
Companies often publish when they will be paying a dividend to investors, and the schedule is often regular. Various websites such as Yahoo Finance and Google Finance help you know when to expect a quarterly dividend in stocks you own.
There are important dividend-related terms to know, and let's start with the first term.
What is the Ex-Dividend Date?
The ex-dividend date is the cut-off date for those who purchased shares in the company to receive the actual dividend, which may be released two or three days later at the record date. A company may announce that it will pay a dividend two weeks in the future, and the stock exchanges will often set an official ex-dividend date two days ahead of the record date.
That's because it can take two or three days for a particular trade to settle, or post officially, and so the ex-dividend date allows investors to know that they can expect to receive a dividend if they purchase a stock before the close of the business day BEFORE the listed ex-dividend date. If you buy on or after the ex-dividend date, your dividend will be x'd out.
What is a Day of Record?
That's not to say you'll automatically receive a dividend if you purchase before the ex-dividend date, and sell before the close of the business day on the day of record, or record date, our second term. You have to be a stock holder on the record books of the company issuing the dividend, and that's why the ex-dividend date exists. But if you sell before the date of record, your shares and ownership will not be recorded on the company's books.
The record date means that anyone who owns shares in the company on the close of the business day will receive the announced dividend payment. The only investors who will NOT receive a dividend payment are those who purchased shares on or after the ex-dividend date. So it's actually possible if you rush in to buy a stock on the record date, that you will not receive the dividend at all.
Should You Buy a Stock Just for the Dividend?
Let me pause right there to make a very important point. You should not buy a stock specifically to collect a dividend. The reality is that the actual price of the stock--the share price--is decreased by the amount of the dividend on the morning when the dividend is paid to investors. In effect, the company is paying part of its profits to investors and its market capitalization decreases by the exact value of the dividend payment it makes to shareholders.
So, let's assume a price of a stock stays absolutely stable for two days from the ex-dividend date to the date of record--that is, the price did not change due to normal trading.
Let's say that you purchased the stock for $50, and expect to receive a 25 cent dividend from the stock.
Though it seems like free money to rush in and buy a company ahead of a dividend, it actually does not work that way in the real world.
You purchased before the ex-dividend date and held through the day of record until the dividend was paid. At that point, you would receive 25 cents for every share you owned--and let's say you owned 100 shares--so in this example you would receive $25.
To get that $25, you paid 100 shares times $50, or $5,000 (five-thousand dollars). Now, you have collected a $25 quarterly dividend, but find out that when you go to sell the shares, you can sell them for $49.75, which nets you $4,975 (four thousand nine-hundred seventy five dollars).
So, you collect $25 for your account if you are signed up for direct deposit, or you receive a check for $25 in the mail. You sell your 100 shares for $25 less than what you paid for them. There was no net gain on your investment. In other words, the $25 is not free money.
So though it seems like free money to rush in and buy a company ahead of a dividend, it actually does not work that way in the real world.
Dividends are wonderful ways to build wealth over time in the stocks in your long-term portfolio, but it's not feasible to trade to profit from a short-term dividend.
Don’t Forget About the Commission
I forgot to mention that you'll be paying commissions on both sides of your trades, and if your commission costs more than the $25 that you received from your dividend, then that's not a good bargain, now is it?!
So unless you have already decided to sell the stock from your portfolio for some other reason, it's probably best not to make any major decisions to buy or sell a stock just because of a dividend.
More About Dividends
Most investors with a long-term horizon turn right around and use the money from a dividend to buy more shares of the stock. That is an excellent way to compound your wealth over time.
The alternative is to receive a check in the mail, or a direct deposit into your brokerage account in the form of a cash balance increase.
And of course, while dividends are great ways to grow wealth, they're not free. You'll pay a tax on the dividends you receive each year. As of October 2010, you'll pay a tax of 15% of the profits on your dividend, and that rate may increase to 20% or more in the near future.
So if you need to know the mechanics of when a dividend is paid, you'll have to purchase shares before the close of the business day of the announced ex-dividend date, and hold them two or three days until the close of the business day of the date of record. You can then sell your shares after receiving your dividend on the morning the dividend is paid.
And although it's not as common, it does happen where an investor will wake up to find a surprise cash present in their account that they were not expecting. Dividends are little gifts that keep on giving, and can surprise you if you're not aware a stock is about to release them, or if a company announces a surprise dividend that you were not expecting.
And if you like the show, tell a friend or leave a review on iTunes. Until next time, this is Andrew Horowitz with The Winning Investor’s Quick and Dirty Tips for Making Money in Any Market wishing you all the best on your quest to investment success.