One of the two main ways of earning returns through stock markets is through capital gains and dividends. Capital gains are the increase in the value of the investment at the time of sale or redemption while dividends are the periodic return from the investment. There are many concepts relating to dividends that have to be considered while aiming for returns through dividends. Some of the key concepts include the ex-dividend price and the implications of trading at such a price. Given below are the details of the same.
What are dividends?
We have all heard the word dividends but not many know the exact meaning of the same. Dividends are the share of the profits of the company that are distributed to the shareholders. These dividends can be distributed annually or semi-annually as per the decisions of the company. Also, it is not mandatory for the companies to declare dividends every year even if they have sufficient profits. However, if they choose to do so, they have to follow the relevant guidelines and provisions issued under the Companies Act, 2013.
What is the record date?
An important concept related to dividends is the record date. It is the date determined by the company on which the names of the shareholders as per the company records are eligible to get the dividend declared. Any shares purchased on or after the record date are not eligible for the current dividends declared by the company. Therefore, the investors need to purchase the shares of a company declaring dividends before the record date to get the immediate benefit of dividends.
What is the cum-dividend price?
The share prices in the market are influenced by a number of factors and one of them is dividends. The frequency and the amount of dividends declared impact the share prices and are key factors for price volatility in the derivative market. When a company declares dividends, its share prices see a favourable increase in the market as many investors look to tap into the opportunity to earn dividend income. Therefore, when the share prices increase after the information of dividends is declared by a company, such share prices are said to be cum-dividend prices. It is the cost of parting the dividend income that the sellers of the stocks include in the share prices. The rate at which the stocks of a company trade from the date on which the company declares dividends till the ex-dividend date is usually known as the cum-dividend price.
What is the ex-dividend price?
Ex-dividend price, on the other hand, is the price at which the shares of a company are traded after the ex-dividend date. This price does not include the benefit of dividends and is, therefore, lower than the cum-dividend price. Investors and traders who purchase the shares after the ex-dividend date are not entitled to receive the dividends declared by the company. The market accounts for this change in the stock prices and thus the same is, therefore, reduced or adjusted.
The formula to calculate the ex-dividend price is given below.
Ex-Dividend stock price = Current stock price or Cum-dividend stock price – Change in stock price due to dividends
Change in stock price due to dividends = Dividend (1-tax on dividends)/ (1-tax on capital gains)
How do investors react to ex-dividend prices?
When a company declares dividends, the immediate impact of the same is seen on the share prices of that company. The announcement of dividends creates demand for the stocks and results in an increase in the share prices. This phenomenon continues till the ex-dividend date as all the eligible shareholders can claim dividends declared by the company.
On the other hand, when the ex-dividend date arrives, the share prices mark a correction and go back to the pre-dividend levels. The demand for the in-dividend stocks reduces resulting in a decline in the share prices. Investors and traders can take this opportunity to include good quality stocks in their investment portfolios that can ultimately provide higher returns. Also, certain stocks are high dividend yield stocks and are known to declare dividends year on year basis. Such stocks can be an excellent source of passive income for the investors and therefore, including them at the ex-dividend prices is also a good opportunity in case the investors have missed the current dividends declared by the company.
Conclusion
Ex-dividend prices and cum-dividend prices are key concepts that have to be accounted for in the trading and investing strategies to have a net profitable portfolio. Stocks trading at ex-dividend prices usually see a slump or a reduced demand. However, this slump in demand can be temporary if the stocks are backed by strong fundamentals of the company or a monopolistic position in the industry or the market.
FAQs
No. ex-dividend price is always lower than the cum-dividend price as it does not include the benefit of dividends declared by the company.
Yes. If the investor purchases the shares of a company declaring dividends before the ex-dividend date, such an investor is eligible to receive the current dividends as their name will be included in the shareholder’s register before the record date.
Ex-dividend date depends on the record date set by the company and is considered to be 2 days before such record date.
Once the dividends are declared by the company, they are not immediately distributed to the shareholders. They are distributed within 30 days from the date of announcement of dividends in case of interim dividends or within 30 days from the date of AGM in case of final dividends. The date on which the said dividends are distributed by the company in either of the two cases is known as the payment date.
