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With every stock going ex-dividend, the stock price seem to drop by the amount of dividend per share.

A few observations:

  • The dividend seems to be earned at the cost of capital gain. The amount gained through the dividend is offset by unrealised capital gain on the ex-dividend date.
  • Also this prevents long term capital gains tax benefits (50% discount here in Australia) and you end up paying the full marginal tax (at least in Australia).

I am ignoring special dividend that types are fully/partially tax exempt (franked dividends in Australia for example).

This means I would end up paying more tax if I got dividends (as opposed to capital gains).

I am sure I am wrong somewhere; can someone please explain how are dividends beneficial (at the cost of share/stock price)?

psmears
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fahmi
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    Dividends are just about the only way stockholders can make money without other stockholders losing it. And no, stock price isn't money. – user253751 Jan 10 '24 at 09:22
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    Dividends can be taxed at a higher rate than capital gains. The two advantages of dividends are reduction of cash at risk and compounding, if reinvested. – Bob Baerker Jan 10 '24 at 16:41
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    One thing people often forget is that a dividend is money. Stock value is not money. – Mark Jan 10 '24 at 22:15
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    There is more than one investor (type) some want an income along with the ownership hence dividends. Many income funds you hear about keep a proportion of their funds in high dividend paying shares. These desires are catered to in part by shareholder surveying and the annual meeting voting. – civitas Jan 11 '24 at 19:30
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    I'm very surprised none of the answers here have considered share buybacks as an alternative to dividends. At this stage, all answers seem to assume that if a company doesn't pay dividends, they're either hoarding cash or investing in growth. – craq Jan 12 '24 at 09:22
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    @craq they're kind of a wacky alternative to dividends and unless the market is very liquid, the way they affect the investors is rather weird, compared to the dividend which is straightforward and simple. – user253751 Jan 12 '24 at 12:00
  • @user253751 for companies listed on a public exchange, I would have expected the liquidity to be high enough. Definitely any company in the S&P500 or ASX50. The benefits of delaying a taxable event for those who don't need the income (with compounding gains in the meantime), combined with a lower tax rate (in many jurisdictions) should be significant advantages for investors. – craq Jan 12 '24 at 18:30
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    @craq there are investors who are actually interested in an income stream and do not want to liquidate positions. Companies with consistent dividend payouts regardless of cyclical market pricing provide such a revenue stream. Buybacks usually benefit either opportunistic investors or people optimizing for capital gains taxation advantage, which skews the market quite a bit. In many countries there's no long term capital gains tax advantage, so reducing dividends reduces investments from these countries. On the flip side, in the US, long term holding dividends are taxed as long term cap gains. – littleadv Jan 12 '24 at 21:29
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    An investor in a company doing buybacks can still have an income stream. It's possible to completely replicate the dividend scenario - if that's what they want. Say a company pays 3% of their market cap in dividends. If they switch to doing buybacks, I can sell 3% of my shares. I'll have the same income stream and my remaining shareholding will be the same percentage of a company with the same valuation. (In the past selling 3% of a small portfolio wouldn't make sense, but now we have low brokerage fees and fractional shares.) Surely a good trade-off for the majority of buy-and-hold investors? – craq Jan 14 '24 at 21:59
  • @craq: Support for fractional shares continues to be really scant. Most brokers only allow accumulating fractions as a result of dividend reinvestment. – Ben Voigt Jan 30 '24 at 17:18

9 Answers9

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We have questions on this site wondering why people would people invest if a company doesn't pay any dividends.

You are asking the opposite question: why would I want a dividend?

The answer is that it depends on what the investor is trying to do at that stage of their life. Some want a series of dividends that they will use to augment their income without the need to sell any shares. Some have their investments in tax deferred or tax free investments; so the tax impact is either delayed or avoided.

One way to evaluate an investment is its tax impact on your finances.

Some people see a growing dividend as a sign of company health, others see it as a wasted opportunity to grow the company by reinvesting profits back into the company.

Interpret the benefit of dividends based on your needs and your view of dividends.

mhoran_psprep
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Dividends are a way for shareholders to get some cash out of their investment without having to sell their shares. In the early days of the stock market, stocks could only be bought and sold in lots of 100, so if you wanted any cash back you had to sell an entire block. As time goes on it's more possible to buy/sell smaller lots (though still not always possible) but dividends became a way to give owners part of the earnings of the company without having to reduce their ownership.

Yes, they are often taxed differently (and sometimes taxed more than capital gains) but that's a decision each investor has to make - whether to buy stocks that pay dividends to get periodic cash out even if taxed differently or buy-and-hold to get cash back on their timeline.

D Stanley
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    Note that this also means you extract the value without having to pay a broker's fee. Less of an issue now with discount brokerages, but it could make a difference. One investment model's goal was to get to a point where you could live on the dividends alone; "just sit back and clip coupons ." – keshlam Jan 11 '24 at 01:57
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    That coupon clipping was usually done to bonds. When I was a wee boy interested in plutocracy, I followed the stockexchanges TSE and NYSE in the hyper expensive (for a ten year old) Financial Post and a trade on a broken lot was beyond my dreams - things have changed for the better. – civitas Jan 12 '24 at 00:17
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    @civitas: in the US less than 100 shares used to be called 'odd' lots, a less alarming name, but they were equally unavailable :-) – dave_thompson_085 Jan 31 '24 at 08:08
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How is dividend good for stock/share investors?

You're thinking about this from the perspective of the small shareholder. But you, the small shareholder, are not making the decision to issue a dividend. The major shareholders are making that decision, and they're doing it to benefit themselves.

If a company has a mountain of cash and the owners literally do not know how to spend that cash to generate more profits, they'll just take the cash for themselves. Dividends are the legal mechanism for taking money out of the company's bank account and putting it into the owners' bank accounts.

See Microsoft in the early 2000s for example. Bill and Steve wanted cash to buy stuff. The company had cash and was generating more all the time. They would rather have that cash in their pockets than pay their workers more or invest in a new line of business, so they issued a dividend.

Eric Lippert
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    Bill and Steve didn't need cash dividends to buy stuff. They would get loans, and the value of the shares they held would make them good loan risks. This is the same reason why Trump inflated the value of his real estate holdings (which he's now being tried for in NYS), so he could get favorable loan rates. – Barmar Jan 11 '24 at 16:22
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    @Barmar: Borrowing against your stock risks you getting called if the stock declines, and it doesn't solve the fundamental problem Bill and Steve had: Microsoft had literally more money than they knew how to spend. Google solved this problem by incentivizing employees to find new lines of business, but Microsoft's internal culture at the time was one of protecting existing baskets of eggs, not finding new ones. – Eric Lippert Jan 11 '24 at 18:15
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    So is your position that dividends are good for all owners (stockholders), just the major owners, or no one? I would argue that they treat all stockholders equally, just proportional to their ownership (everyone gets the same amount per share). – D Stanley Jan 11 '24 at 19:24
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    @DStanley: No. My position is that if you want to understand the reasons why companies issue dividends -- which is the question that was asked -- you should focus on whether the people making that decision stand to benefit personally from the decision! – Eric Lippert Jan 11 '24 at 19:38
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    Comments have been moved to chat; please do not continue the discussion here. Before posting a comment below this one, please review the purposes of comments. Comments that do not request clarification or suggest improvements usually belong as an answer, on [meta], or in [chat]. Comments continuing discussion may be removed. – GS - Apologise to Monica Jan 12 '24 at 19:45
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A dividend is beneficial to stockholders because it increases the return on their investments.

Suppose a company has a market cap of $10,000,000 and $1,000,000 in excess cash in the bank at the beginning of a year. It may or may not issue a dividend to get rid of that $1,000,000 in cash. Then suppose it makes $1,000,000 in profit over the rest of that year.

First, let's try with no dividend: The company is worth $10,000,000 and makes $1,000,000 in profit. That's a 10% return for shareholders.

Now, let's try with a dividend to get rid of that excess cash: Since the dividend reduced the share price, the company's market cap also dropped by $1,000,000. So the company has a market cap of $9,000,000 after the dividend. The $1,000,000 in profit therefore represents an 11% return for shareholders.

An 11% return is better than a 10% return. Over a few years, this would add up quite significantly.

Of course, if there's something even better they could do with the cash, they should do that. But the point is that dividends do increase returns for investors, so other things they might do with the cash have to compete with the benefits of dividends. But if the company can't do anything useful with the cash, forcing investors to own idle cash drags down their returns.

This means I would end up paying more tax if I get dividends (as opposed to capital gains).

Correct. But if you have a capital gains tax rate of zero or hold investments in a tax-advantaged account of some kind, that doesn't much matter.

David Schwartz
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    Exactly. Stripped of the math, when a company keeps a lot of cash on the books (and they have no investment use for it), they are making their investors take their equity investment with a side-order of cash, and that depresses returns. Often investors don't want that; they want their stocks al-la-carte, so to speak. – Nobody Jan 10 '24 at 18:36
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    Good answer but think it should explicitly state in its assumptions, that this example assumes profit is not increased by avoiding the dividend. ie: it assumes that the cash cannot be invested by the company [which of course is a major consideration the business must make, but I think highlighting it would be valuable to a user asking the type of question being asked here]. – Grade 'Eh' Bacon Jan 10 '24 at 18:52
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    @Grade'Eh'Bacon I added a paragraph to clarify. – David Schwartz Jan 10 '24 at 21:58
  • Sorry I got confused and thought the $1M profit is what generated the $1M cash, when you meant for there to be two separate $1M. – Ben Voigt Jan 10 '24 at 22:06
  • @BenVoigt I edited a bit to make it clearer. – David Schwartz Jan 10 '24 at 22:34
  • I'm not really following this logic. Are you saying, as an investor, that you want the stock price to go down so that the company's profits look bigger in comparison? If the market cap drops by 90%, that would mean a 100% profit relative to the market cap. Or it could drop by 99% and it would be a 1000% profit relative to market cap. – JimmyJames Jan 12 '24 at 17:02
  • @JimmyJames as an investor, you want the company to avoid holding unproductive assets on its balance sheet. Returning cash to investors if you don't have a better use for it reduces the stock price, but existing investors are no worse off because they receive the cash from the dividend. The corresponding increase in return on equity is indicative of a company using capital more efficiently. – Nobody Jan 12 '24 at 17:14
  • @Nobody Referring to issuing a dividend an efficient use of capital is a little odd but don't get me wrong. I have nothing against dividends. There are many companies that would have better served investors by paying a dividend than throwing money away on ill-conceived attempts at growth and/or diversification. But I don't think this answer holds together logically. If you look at the MSFT price example in my answer, the stock price recovered from the ex-dividend drop in 2 days. Should MSFT investors despair at that performance? – JimmyJames Jan 12 '24 at 17:35
  • @JimmyJames Issuing a dividend is not using capital at all; it is returning that capital to investors so that they can put it to whatever use they see fit. The idea is that if a company doesn't have a use for those assets, it shouldn't hold on to them. Capital is being used "more efficiently" because the company is using less capital to achieve the same results. – Nobody Jan 12 '24 at 18:10
  • If you're still not convinced, try this thought experiment: say you propose to invest in my company FooCorp, and I tell you that I can either take all of your money and put it to work earing X% return selling widgets, or I can take half of your money and put it to work earning the same X%, and I'll put the other half in a savings account earning little to nothing. Which plan is more attractive? Keep in mind that if you wanted to put your money in a savings account, you could have done that without my help. – Nobody Jan 12 '24 at 18:11
  • @Nobody I am totally in agreement with your last comment but that's not what this answer is arguing. Lowering the P/E multiple makes a stock more attractive to buyers, but it doesn't really benefit existing holders (unless they want to increase their position, of course.) Holders want a high price for their shares, not a lower price. – JimmyJames Jan 12 '24 at 19:05
  • @JimmyJames Of course the dividend benefits existing shareholders. It's a mistake to think that you want your share prices to be as high as possible. What you want is for your investments to earn you as much as they can while tying up as little of your money as possible. When a company pays you a dividend it reduces the amount you have invested while still giving you the same future earnings. IOW, a stock's price is partly due to the value of its future earnings and partly due to the value of its assets. You want the former to be high, but you want the latter to be as low as possible. – Nobody Jan 12 '24 at 19:34
  • @Nobody "It's a mistake to think that you want your share prices to be as high as possible." Please don't put words in my mouth. I never claimed that. I said investors prefer a higher price for their shares over a lower price. If I get a dividend AND the price goes up, that's preferrable to getting a dividend and having the price go down. Even if I want a dividend, investors do not desire a decrease in the value of their stock. They might accept it, but no one (typically) is rejoicing because the market cap of the company was reduced. – JimmyJames Jan 12 '24 at 19:39
  • @JimmyJames You are comparing numbers that can't be compared with each other because you're ignoring differences between multiple scenarios such as comparing share prices in some cases and market caps in others in cases where the number of outstanding shares differ. Other things being equal (and that's key here!) yes, investors prefer a lower share price because that means that the same amount of profit (whether as a dividend or as a share price increase) reflects a higher return on their investment, and they want high returns on their investments. – David Schwartz Jan 14 '24 at 04:28
  • @DavidSchwartz Can you show me some examples of where CEOs were lauded for reducing the share price? Would you really be happy if the value of one of your holdings went down by say 50%? I mean in reality. – JimmyJames Jan 16 '24 at 15:42
  • @JimmyJames You can find lots of articles where people recommend companies based on their generation of dividends, and each dividend drops the stock price by the dividend amount. So, yes, people do laud companies for reducing stock prices because it increases returns, as I explained. If I held the stock in a retirement account, I'd be much happier if it went down by 50% due to a dividend because my return on the next dividend would be doubled (I'd use the dividend to buy more shares) because I would own twice as many shares and the dividend per share would be the same. – David Schwartz Jan 16 '24 at 19:46
  • @DavidSchwartz Can you point me to any example at all? You are making an extraordinary claim here that doesn't agree with my graduate-level finance education or anything I've ever heard or read on the subject. The math you show for why a price decrease is 'good' doesn't include dividends. Any decrease in the price for any reason would have the same effect. If you are claiming this is something specific to dividends, you need to factor that into your calculation. Your metric is the inverse of the P/E ratio. – JimmyJames Jan 16 '24 at 20:32
  • @JimmyJames What do you want an example of? Dividends always bringing stock prices down? Or companies being praised for high dividends? And the math is super easy, you can find it in my answer. A lower stock price, all other things being equal, means a higher rate of return. The math is absolutely trivial. And it's not true that a decrease in price for any reason can have the same effect because, for example, a decrease in price due to reduced profits means a loss of investor value while a dividend doesn't -- and I said all other things being equal. – David Schwartz Jan 17 '24 at 03:38
  • @DavidSchwartz I'm looking for an example of someone, anyone claiming that, e.g., a CEO was really great for a company for making the stock price decrease. Or something like someone cheering that the market is down because somehow, that's a good thing. – JimmyJames Jan 17 '24 at 15:23
  • @DavidSchwartz "The math is absolutely trivial" Yes. So trivial as to be silly. – JimmyJames Jan 17 '24 at 15:24
  • @JimmyJames Again, it flows directly from two very simple facts that I can easily provide evidence for or that you can easily find evidence for on Google that are virtuall indisputable. 1) An $x/share dividend causes the share price to go down by $x. 2) CEOs and companies are frequently cheered for reliable and sustained dividends, even though each one drops the share price. I don't know what I can do about you being unable or unwilling to combine these two things together. And it does in fact increase shareholder returns because it makes the denominator smaller. – David Schwartz Jan 19 '24 at 07:21
  • @DavidSchwartz The simple nominal value of a stock to an investor in simple terms is (S - B) + D where B is the purchase price, S is the price it is sold at, and D is the distributions received. This is the nominal value because it doesn't consider the time value of money and of course, this ignores taxes, fees or other investor costs. If the stock has not been sold, the S - B term is called the unrealized gains (or losses.) It should be plainly obvious that the price of the stock being reduced does not increase gains. The value of a dividend to the investor is the distribution. – JimmyJames Jan 19 '24 at 14:18
  • @JimmyJames That is complete nonsense. First, the distribution already belongs to the strockholders. The distribution only moves it from one place they hold value to another place they hold value. It is not a net gain. But it does lower stock prices. With lower stock prices, other things being equal, each investor owns more shares. So for the same per share dividend, they get more dollars. The fact that distributions hold share prices down and increases yield from both future increases in market cap and future dividends is the key benefit of dividends to investors. – David Schwartz Jan 20 '24 at 00:07
  • I don't think we are going to get anywhere. I'll just stick with what I learned in grad school and you can believe whatever this is. – JimmyJames Jan 22 '24 at 15:21
  • @DavidSchwartz Sorry, I have to know how you think this works: "With lower stock prices, other things being equal, each investor owns more shares" How does a lower price mean investors own more shares? – JimmyJames Jan 22 '24 at 18:13
  • I'm starting to wonder if people have got stock dividends confused with cash dividends. – JimmyJames Jan 22 '24 at 18:28
  • @JimmyJames If you have $100,000 invested at a $10 stock price, you have 10,000 shares. If you have $100,000 invested at an $8 stock price, you have 12,500 shares. So for the same number of total outstanding shares of the company (which a dividend does not change) the same amount of earnings will produce a higher earnings per share with a lower stock price. All other things being equal (like market cap, amount invested), lower stock prices give higher returns than higher stock prices. For those who reinvest dividends, a dividend keeps the amount invested the same. – David Schwartz Jan 22 '24 at 23:54
  • @DavidSchwartz You don't get more shares if the stock price drops regardless of whether there is a dividend or not. You can buy more shares if you like but that's a new investment. You understand dividends are only given to existing holders of shares right? What does purchasing new shares have to do with anything? – JimmyJames Jan 23 '24 at 15:10
  • @JimmyJames One option investors have is to reinvest dividends. If they do that, then whenever there's a dividend, they use that dividend to buy more stock. Investors will only not reinvest dividends if not reinvesting dividends is even better for them than reinvesting dividends. And if they reinvest dividends, then the number of shares they own will go up with each dividend. The number of shares outstanding will not change. So the percentage of the company's future appreciation that that investor captures goes up. – David Schwartz Jan 24 '24 at 15:06
  • @JimmyJames And, again, dividends reduce the stock price by the amount of the dividend. And they are nearly the only way for the stock price to drop that keeps all other things equal. (For example, if the stock price drops due to changes in the expected future value appreciation of the company, that is no longer equal before and after.) All other things being equal, a lower stock price is better than a higher stock price because it means investors get higher returns from the, assumed equal, future appreciation. – David Schwartz Jan 24 '24 at 15:07
  • @DavidSchwartz As far as I can tell, you are making this stuff up. – JimmyJames Jan 24 '24 at 16:22
  • @DavidSchwartz "a lower stock price is better than a higher stock price because it means investors get higher returns from the, assumed equal, future appreciation" So you are saying that if I buy a stock and its price drops, I benefit. How is that exactly? The amount you get from selling a stock only depends on the purchase price and the sale price. For example, if I buy a stock at 10, and it goes to 100 and then I sell at 20, the gain is 10. If I buy a stock at 10, and it goes to 5 and then I sell at 20, the gain is 10. You agree with that, right? – JimmyJames Jan 24 '24 at 16:27
  • @JimmyJames I said all other things being equal a lower stock price is better. In your examples, value is destroyed. We're talking about dividends which lower stock prices and leave all other things equal, that is, they don't destroy value. It really seems like you're deliberately trying to not listen to the very simple things I'm explaining. To fix your example, when it goes down to 5, the value should go somewhere else, say into doubling the number of shares of stock you hold (so price drops but other things are equal). Then the increase from 5 to 20 is multiplied by twice as many shares. – David Schwartz Jan 24 '24 at 19:00
  • @DavidSchwartz " In your examples, value is destroyed." In my last example, the value was not destroyed. Perhaps you should review it. – JimmyJames Jan 24 '24 at 19:52
  • @DavidSchwartz "To fix your example, when it goes down to 5, the value should go somewhere else," This seems pretty confused. What do you mean, 'go somewhere else'? What is going where? The market price of a stock is the last price it was traded at. No more, no less. The money you spent on a stock is already gone. That's what a trade is. The buyer exchanges cash (typically) for shares from the seller. The seller gets the money, the buyer gets the shares. – JimmyJames Jan 24 '24 at 19:58
  • @JimmyJames In your example, when the stock price dropped from 10 to 5, you didn't keep all other things equal. You destroyed half the value of the company and you decreased the amount invested. You could have kept those things equal -- for example, you could drop the price from 10 to 5 with a dividend and keep the position equal by having the investor use the dividend to buy more shares at the post-dividend price. That would drop the price but keep everything else equal. Then the rise from 5 to 20 would be twice as good. Other things equal, lower prices mean higher returns. – David Schwartz Jan 24 '24 at 20:01
  • " In your example, when the stock price dropped from 10 to 5, you didn't keep all other things equal. You destroyed half the value of the company and you decreased the amount invested." Huh? How did the amount invested decrease? I said I spent 10 on the stock. That's the amount invested. Have you ever purchased stock? – JimmyJames Jan 24 '24 at 20:05
  • Check this article out. The section about the secondary market is what applies here: "Unlike IPOs, money spent in secondary market transactions doesn’t go to the company that issued the shares. It goes instead to the investor who sold them to you." There's an example in the follow section that's worth looking at as well. – JimmyJames Jan 24 '24 at 20:28
  • @JimmyJames What does that have to do with anything? The whole point of the dividend is to decrease the value of the company so that the same amount of future income is a higher percentage of the cost to hold a given percentage of the company. If the money went to the company, the entire objective of getting rid of the money would be frustrated. (The value of the money is transferred to the investors who can get a way better return than the company could just holding it in their bank account, for example by using it to buy more shares of the company.) – David Schwartz Jan 24 '24 at 23:23
  • What does the fact that you apparently don't know what it means to buy a stock have to do with your gross misunderstanding of what a dividend is? Quite a lot, in my estimation. – JimmyJames Jan 25 '24 at 15:18
  • Let us continue this discussion in chat. – David Schwartz Jan 26 '24 at 07:50
5

What dividends provide to investors is predictable income. While the dividend rate can change, lowering the dividend is a big red flag that the company is having financial troubles. So if you're invested in a company that's in decent shape (and why invest in anything else?), you can expect that the dividend will at worst stay the same, and may even increase in the future. The board of directors does have to declare the dividend before paying it out, but this is usually just a rubber stamp to keep it the same.

You can get cash by selling shares, and the tax impact of capital gains is indeed better than that of dividends in many places. But share prices fluctuate significantly, even for companies that are in good shape (often opinions of an entire industry will sour, and most companies in that industry will see their prices drop).

A common scenario is that retirees will invest in dividend-producing stocks. If you're no longer earning a regular salary, you want some other regular source of income, and dividends provide that. Without dividends, you're at the vagaries of market prices, and crashes become more scary.

Barmar
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  • Comments have been moved to chat; please do not continue the discussion here. Before posting a comment below this one, please review the purposes of comments. Comments that do not request clarification or suggest improvements usually belong as an answer, on [meta], or in [chat]. Comments continuing discussion may be removed. – JohnFx Jan 30 '24 at 22:57
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With every stock going ex-dividend, the stock price seem to drop by the amount of dividend per share.

A lot of good discussion here on the value of dividends but I don't see anyone addressing this common source of confusion.

The stock price doesn't 'seem' to drop by the amount of the dividend. What you are noticing is that exchanges (in the US, at least), are required to mark down the last traded price by the amount of the dividend on the ex-dividend date. For example, Let's say a company issues a $1 dividend with an ex-date of today, and the last trade recorded yesterday was $100. The 'adjusted close' will be $99. When trading opens today, the last trade price will be reported as $99. The key is to understand that the actual last trade was made at $100.

If you want to see a real-world example, you can look here at MSFT price history on yahoo finance. Note that there are two 'close' columns: 'Close' and 'Adj Close'. They are almost always exactly the same. Scroll down until you see a dividend line. At the time of writing, the last MSFT dividend was $0.75 on the 15th of November 2023. Look at the price line for the 14th. You will see that the close price was $370.27, and the adjusted close price is $369.52. The difference between the close price and adjusted close price is exactly $0.75, the amount of the dividend. The close price was the actual trade price. The adjusted price is, as the name implies, an adjustment to the actual real trade price. Now look at the prices on the 15th. It opened and closed higher than the adjusted close price. That adjusted close isn't a 'real' price. That's why it is recorded separately in the price history. It's the assumed fair price for that stock after the dividend payment cannot be claimed. Real market prices are set by trades, not the exchange.

So why would the exchanges do this and, moreover, why are they required by regulators to do this? At one point, I tracked down the reasoning behind it and I could probably find it again if necessary. But, from memory, this wasn't always the practice at every exchange. Some did this, some did not, or at least the specifics were not completely consistent, hence the rule. The reasoning for doing this is that, in theory, the value of the stock prior to the ex-dividend date should be priced higher than on the ex-dividend date by the amount of the dividend. If I bought ten thousand shares of MSFT on Nov. 14th for 370.27, I would receive $7500 in cash soon after, effectively discounting the price I paid. If you bought on the 15th at that price, you would have paid much more for the same thing. If I could sell my shares the next day at the same price I bought them, I basically pocket $7500 for free. Back when not all exchanges adjusted for dividends (sometime in the 70s IIRC,) that kind of thing could and did happen when people were not aware of the ex-dividend date. So, regulators decided to make it a rule that prices would always be adjusted down to prevent the unwary from being taken advantage of in this way. This article: "Understanding Ex-Dividend Dates" explains it pretty succinctly:

When a company pays a large dividend, the market may account for that dividend in the days preceding the ex-div date by a rise in the price of the stock. This is because buyers are willing to pay a premium to receive the dividend. However, on the ex-div date, the exchange automatically reduces the price of the stock by the amount of the dividend.

Also here:

The declaration of a dividend naturally encourages investors to purchase stock. Because investors know that they will receive a dividend if they purchase the stock before the ex-dividend date, they are willing to pay a premium.

This causes the price of a stock to increase in the days leading up to the ex-dividend date. In general, the increase is about equal to the amount of the dividend, but the actual price change is based on market activity and not determined by any governing entity.

A really common misconception around this is that somehow the dividend is taken "out of the price". I don't understand what mechanism people think would allow for that, but I've had enough debates about it to know that people really think this, even if they can't explain how that would supposedly work.

The reality is actually sort of the opposite of this, however. The price of a stock will tend to increase between the dividend announcement and the ex-date by the amount of the dividend. This isn't just theory, though, research shows this to be the case.

Here's a really simple analogy: Suppose you have the opportunity to buy two artic magenta Stanley travel mugs. You are sure you can flip them for more money in a few days. One of these mugs has a (real) $100 bill in it. The other is empty. In every other way these mugs are exactly the same. How much more should you be willing to pay for the mug containing the money. Based on basic economic logic, you should be willing to pay up to $100 more for it. At any premium less than $100 you should prefer the mug containing the money. At $100, you should be ambivalent. Now, consider a stock right before and ex-div date and the same stock on the ex-div date. Unless something significant happens the eve of the ex-div date, that stock is the same thing on both dates with one exception, when you buy it on the eve of the ex-div date, it comes with a payment. Ignoring taxes and some other confusing factors, a rational investor will be willing to pay exactly that payment more for the stock on the eve of the ex-div date. It's really that simple.

But, of course, there are many other days when you can buy a stock than that. We need a more complicated analogy for that, imagine I had a goose that lays one golden egg every month on the 1st of the month. For simplicity, assume each one is worth $100,000 and the price of gold is fixed. You wish to purchase the goose and we've come to an agreement on a fair price. Now, if you purchase the last day of the current month, you will get 100 grand the next day. If you purchase on the 1st, I get that egg. So, when do we do the deal? Or rather, how do we come to an agreement on when to do the deal? The simple and fair answer is to prorate the value of the next egg and add it to the agreed price. If you buy on the 1st, you pay no premium. If you buy on the last day of the month, you pay an extra $100K. If you buy halfway through the month, the premium is $50K. This is essentially how accrued interest works for bonds. The logic for dividends is the same with the caveat that bond valuation is a much more precise exercise than stock valuation.

The idea that the dividend comes directly out of the price (how?) or that it is pulled from the company's value is really pretty ludicrous. If that were the case, why doesn't the exchange adjust the price after every payroll or capital expenditure? How or why would the dollars spent on the CEO's bonus be different from the dollars paid to investors as dividends? There's no logical basis for that idea and frankly, it strongly suggests a fundamental misunderstanding of stock/company valuation.

To be clear, paying dividends does have a meaningful impact on a company. That's money that can't be used to fund operations or make capital improvements. Some companies take on debt in order to avoid cutting their dividend. All of this is relevant to valuing the company. But it's not a simple subtraction from the price.

JimmyJames
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This means I would end up paying more tax if I get dividends (as opposed to capital gains).

This very much depends on a country's tax code. For example, in the U.S. dividends can provide a stream of income that is tax free at the federal level for tax payers in certain fairly generous income brackets. From Intuit (my emphasis and bolding):

Ordinary dividends are taxed using the ordinary income tax brackets for tax year 2023. Qualified dividend taxes are usually calculated using the capital gains tax rates. For 2023, qualified dividends may be taxed at 0% if your taxable income falls below:

$44,625 for those filing single or married filing separately,
$59,750 for head of household filers, or
$89,250 for married filing jointly or qualifying widow(er) filing status.

In order to qualify for the 0% tax rate, certain requirements must be met. These are to numerous to list in detail here. To first order there is as minimum holding time for the underlying shares (which may not be part of hedging) and the dividend must be paid by a U.S. company or qualifying foreign company. The conditions are fairly easily met by American long-term retail investors. The applicable tax brackets frequently make this an attractive option for people in retirement that desire a fairly steady and tax-efficient income stream.

Prior to my own retirement, I spent several years slowly transitioning from a mostly growth-oriented stock portfolio to one including many dividend-bearing stocks. Now ten years into retirement I consider this one of my smarter financial moves.

njuffa
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  • As long as you hold over a year, US cap gains are taxed at exactly the same lower rates as qual dividends; since you like Inuit https://turbotax.intuit.com/tax-tips/investments-and-taxes/capital-gains-and-losses/L7GF1ouP8 . And the preferred brackets no longer exactly match the ordinary brackets, although they remain close. Historically longterm gains have gotten lower rates as long as I've been aware, but qual dividends only since 2003. Dividends depend only on the board not the market making them more reliable (and less work) but they're not really better for tax. – dave_thompson_085 Jan 14 '24 at 00:57
  • @dave_thompson_085 Note that I referred to a fairly steady stream of income. I would not associate the act of selling shares with the word stream, just like receiving a stream of income in the form of rent paid by tenants is different from selling the underlying real estate. Other people's notion of an income stream may differ. – njuffa Jan 14 '24 at 01:52
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To answer your question concisely:

Yes. It is more tax-inefficient for you, if the company distributes a dividend. Australia is by far not the only country where this happens. The return of capital to shareholders often depends on the maturity of the company. An alternative for the company could be to buy back own shares. A mix of both can be reasonable for a company, again, depending on the circumstances.

Marco
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What you're witnessing when the share price drops by the dividend amount is a coincidence. The thing to remember about stock price is that they are not the total of the actual assets of the company, but they are what the "perceived" value of the company is by people buying and selling the stock. The reason that the price drops after a dividend is usually because people who are chasing dividends sell these shares and buy shares in another company that has a dividend due. Because they're looking to offload the shares, the price drops.

Similarly, you may see a small spike in your share price in the run up to the dividend date.

This question goes into a load more detail - If stock price drops by the amount of dividend paid, what is the use of a dividend

Matthew Steeples
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    Stock prices usually drop by the dividend amount after the ex-dividend date. One day earlier, the share of stock is worth one share plus the dividend amount, one day later it's worth just one share. There is a simple causal connection between dividend payout timing and stock price, I don't see in what sense this highly repeatable and explainable effect can be called a "coincidence". – Nuclear Hoagie Jan 10 '24 at 21:01
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    If a company has $1 million in cash on Monday and Tuesday everything else is the same but the cmopany doesn't have that $1 million in cash, the company is worth $1 million less. Why try to make that seem complicated? – David Schwartz Jan 10 '24 at 21:59
  • @NuclearHoagie OK so coincidence is not the right word, but the cause and effect isn't as direct as that. Shares are "worth" what people are prepared to pay for them. Share prices are affected by but not directly linked to the assets of the company. They're affected by opinions, market factors, and only change when shares are bought and sold, because they reflect the value of the last trade. The share price dictates the value of the company, not the other way around. – Matthew Steeples Jan 11 '24 at 13:31
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    @MatthewSteeples But unless there's some news related to the company coincidental with the dividend, the only change to the company is the cash that has left its bank account. So rational investors will simply reduce what they're willing to offer by the amount of the dividend. And in practice, this is what usually happens. – Barmar Jan 11 '24 at 16:28
  • JimmyJames's answer explains it clearer than mine does – Matthew Steeples Jan 11 '24 at 19:50
  • What you're witnessing when the share price drops by the dividend amount is a coincidence. Stock exchanges reduce share price on the ex-dividend date by the exact amount of the dividend. And because of this, FINRA Rule 5330 (Adjustment of Orders) requires that all open orders must be reduced by this amount unless the dividend is less than one cent or the trader marks the order "Do Not Reduce". – Bob Baerker Jan 11 '24 at 22:51
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    I think 'coincidence' isn't really the word you mean here. – JimmyJames Jan 11 '24 at 22:53
  • The answer is overall correct. The price drops because traders think the price should drop, so it becomes a self-fulfilling prophecy. Traders have good reason to think the price should drop, but it's important to point out the price is not linked to any underlying reality, only the feelings of traders, and markets are very often irrational for long periods of time. – user253751 Jan 12 '24 at 00:20