How do Dividends work?

Dividends simply put, are profits given in the form of cash to the investor. Dividends are declared by the company in the form of dollars and cents regardless for the most part of the actual price of the stock. Example: If a stock yield is 10% then a $10 stock will pay $1 in dividends. Now here’s the important thing to remember! If the price of the stock goes up or down, the stock will still pay $1. If the stock price drops by a couple dollars and the company still declares the same dividend you still get $1.

When we talk of dividends we usually talk about yield. Yield = dividend/stock price. This is expressed in percent. Falling stock prices raise yield and rising prices decreases yield.

Usually a broad based hit to the market will drop the price of the stock without affecting the fundamentals. As such a drop in price will leave the payout of the dividend alone. Thus, a falling stock price will produce a higher yield.

Look at the EPS, or Earnings Per Share. How much of the earnings does the dividend represent. In some cases you’ll see quarters reported where earnings are less than the dividend. That can be a danger signal if the situation is long term. One time charges for loan repayment, stock buybacks, etc. usually are not significantly detrimental to dividends by themselves. Always keep an eye on news and fundamentals though to make sure there aren’t other factors coming into play.

Eligibility for a dividend requires you to own the stock on the date of record. It takes 3 business days for a stock purchase to clear. So counting backwards you must own the stock 3 business days prior to the date of record. On the day after that date, which we call the Ex-Date, stock purchasers will not be eligible for this payout. On Ex-Date the stock will be reduced in value automatically by the exchange by a rate equal to the dividend payout.

So, is it better to buy before or after ex-date. That’s a matter of debate. Some argue it’s better to buy before ex-date. They make the point that with higher yielding equities such as Mreits institutions buy up the stock after ex-date and drive the price up, making it tough to catch it at the bottom. Others argue you can get a better deal after ex-date because the short sellers go back on and drive the price down. Look at the previous ex-dates and see if there’s a pattern. It may give you an idea of which path to take.

And that’s all for now about Dividends.

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