How dividends may affect stock prices

Stocks that pay consistent dividends are popular among investors. Though dividends are not guaranteed on common stock, many companies pride themselves on generously rewarding shareholders with consistent – and sometimes increasing – dividends each year. Companies that do this are perceived as financially stable, and financially stable companies make for good investments. It is commonly believed that when companies display consistent dividend histories, they become more attractive to investors. As more investors buy in to take advantage of this benefit of stock ownership, the stock price naturally increases, thereby reinforcing the belief that the stock is strong. If a company announces a higher than normal dividend, public sentiment tends to increase; however when a company that traditionally pays dividends issues a lower-than-normal dividend, or no dividend at all, it may be interpreted as a sign that the company has fallen on hard times.

The truth could be that the company's profits are being used for other purposes, however the market's perception of the situation is always more powerful than the truth. Before jumping to assumptions however, one must note that dividends are distributed by first declaring the dividend amount and the date when it will be paid. The company must also announce the last date when shares can be purchased to receive the dividend. This date is generally two business days prior to the date of record, which is the date when the company reviews its list of shareholders.

This declaration of a dividend naturally encourages investors to purchase stock as 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 stock to increase in the days leading up. In general, the increase is about equal to the amount of the dividend, but the actual price change is mainly based on market activity and not determined by any governing entity.

Many people invest in certain stocks at certain times solely for the purpose of collecting dividend payments. Some investors purchase shares just before the ex-dividend dates and then sell them again right after the date of record; which if carried out with a strategic notion, could result in a sizable profit.

This article was issued by Steve Diacono