Buy stocks before dividends

On September 8, 2017, XYZ Corporation announced a dividend payable on October 3, 2017 to its shareholders, and that shareholders of record in the company’s books on or before September 18, 2017 are entitled to the dividend. The stock will then go into the ex-dividend one business day prior to the record date.

Excluding weekends and public holidays, dividends are determined one business day prior to the date of registration or market opening. With a large dividend, the share price may drop to the same amount as in the previous dividend.

Sometimes a company pays dividends in the form of shares rather than cash. Dividends may be additional shares in the company or in a subsidiary that is spun off. However, the procedures for stock dividends may differ from cash dividends, in that the dividend date is set on the first business day after the dividend is paid.

If you sell your shares before the ex-dividend date, you also sell your right to the dividend. Your sale includes an obligation to deliver any shares obtained as a result of the dividend to the person who purchased your shares from you. Thus it is important to remember that the day you can sell your shares without being obligated to deliver the additional shares is not the first business day after the record date, but is usually the first business day after the dividend has been paid.

Dividends are an important part of investing for long-term growth, but the mechanics of their payment can be confusing for investors of any level. The frequently asked question about dividend stocks is: When should I buy a stock in order to receive the dividend?

When most dividends are announced, the company generally says they are “payable to shareholders of record as of” a certain date. This is useful information, but investors often mistakenly assume that the record date is the date they need to buy a stock in order to receive the dividend.

Stock trades actually settle three days after they occur, even if you are a frequent trader who buys and sells the same stock several times a day. This means that you need to buy a stock three days before the record date in order to qualify for the dividend.

To complicate matters further, the ex-date is two days before the date on which you must be a registered contributor. We’ve established that the must-have date falls three days before the record date, so the simple subtraction process means that you should buy a share one day before the dividend.

Why don’t investors buy stocks just before the ex-dividend date and then sell?

Investors make money from the stocks they own in two ways: selling the stocks when the price goes up and receiving dividends from the stocks they own. However, buying before the dividend and selling immediately after is usually not a way to make money because the market responds to the dividend payment by adjusting the share price to the value of the payment.

When a company declares a dividend, it promises to pay investors out of its cash pool based on the number of shares each person owns. For example, if a company announces a dividend of $1 million, that company must provide $1 million in cash to make the payments. When a company declares a dividend, it also sets a standard date, which is the date you need to register as a shareholder to receive the dividend. Whoever owns the stock on that date gets the dividend.

Because paying a dividend reduces the amount of money a company is worth, the stock market responds by lowering the price of the company’s stock. For example, suppose a company is valued at $50 million and has 2.5 million shares outstanding. Based on this valuation, the investor would be willing to pay $20 per share. If the company paid out a dividend of $1 million, or 40 cents per share, the company would still have 2.5 million shares outstanding, but only worth $49 million. So after the dividend, the market will value the stock at only $19.60 per share.

Even though the share price drops after the dividend, the existing shareholders don’t lose. Instead, their wealth takes a slightly different form as it is split between a diluted stock value and a dividend payment. Let’s say you own shares worth $20 per share before a 40 percent dividend per share. After the dividend, your share will only be worth $19.60. However, you now have 40 cents in your pocket from your dividend payment. Adding 40 cents of dividends to the value of your stake of $19.60 puts your total value at $20, exactly what it was before.

Another disadvantage of buying and selling stocks in a short period of time is the higher tax rates on any profits you may make. Any time you earn a profit from the sale of shares that you’ve owned for a year or less, those profits are taxed at ordinary income tax rates rather than lower long-term capital gains rates. In addition, if you did not own the shares for more than 60 days within the 60 days before and 60 days after the stock’s ex-dividend date, your dividend cannot be a qualifying dividend, which means that the payment is also subject to tax.

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