By Rajat Maheshwari
What is Dividend Policy?
Dividend policy is the procedure a firm follows to organize its dividend payment to shareholders. When a company makes a profit, it must decide what to do with it. They can either keep the profits in the company as retained earnings on the balance sheet or they can distribute the money to shareholders in the form of dividends. The dividend policy used by a company can affect the price of the share, having said thatsome experts claim that the dividend policy has no bearing on changes in stock prices. The chosen policy must be in line with the company's goals and maximize the value for its shareholders. While the shareholders are the owners of the company, it is the board of directors who make the calls to either distribute or to retain profits. Directors must consider many factors before taking this call, such as the company's foreseeable future expansion plans and investment prospects
How Dividends Work?
Investors often rely on dividends as a way to supplement their income from their portfolios. For the issuing company, they represent a way to redistribute profits to shareholders as a means of thanking them for their support and encouraging further investment. Paying dividends is a public statement about the financial health of a business. As dividends are paid from a company's retained profits, only consistently profitable enterprises pay dividends. Dividends are often paid in cash, but may also be issued in the form of additional shares. In both cases, the amount each investor receives depends on their current ownership stakes. If a company has paid up capital of one million in the form of 10000 shares for a face value of Rs.100 each and declares a dividend of 50 cents, then an investor with 100 shares will receive Rs.5000 and the company will pay out a total of ₹500,000. If it issues a 10% stock dividend instead, the same investor will receive 10 more shares and the company will give away a total of 100,000 new shares.
The Psychology of Buying Stock on Ex-Dividend Date:
Investors want to invest in companies that provide stable dividends over the years. Some investors also invest in companies that decide to offer dividends and sell them after they receive the dividend to take advantage of the opportunity for a quick profit. SEBI guidelines pertaining to dividend distribution upon how and to whom these dividends are distributed on the basis of Ex-Dividend Date . The issuing company must first declare the amount of the dividend and the date on which it will be paid. It also announces the deadline on which the shares are to be purchased to receive dividend, the first business day following the stock dividend payment is called as the Ex-Dividend date. Additionally one business day before the record date is also called as Ex- Dividend Date, which is the date the company reviews its list of shareholders.
The announcement of a dividend naturally encourages investors to buy shares. Stocks trade at a premium before the ex-dividend date because buyers anticipate receiving a dividend if they purchase shares before that day. This will result in a rise in the share price in the days leading up to the ex-dividend date. Generally, the increase is approximately equal to the amount of the dividend, but the actual price change is based on market activity and is not determined by any governing body.
Many people invest in certain stocks at certain times only to collect dividends. Some investors buy stocks right before the ex-dividend date and then sell them again right after the ex-dividend date, A capital market’s tactic that can result in a net profit if done right.
The Change of Stock Price on the Day of Dividend:
Each dividend paid by a firm has the potential to be either larger than anticipated or lower. The stock price is susceptible to fluctuations and changes depending on a number of factors that the statement made. Here we can take an example of two scenarios. The first scenario is when Dividend declared is lower than expected It can cause the stock price to fall and even investors start speculating on the reasons for the same. On the other hand, When Dividend declared is higher than expected. When such a scenario occurs, the market sentiment of the company will undoubtedly cause the share price to rise and even investors will question whether the company is seeing significant growth.
The Dividend Rally:
The payment of dividends is not a surprise event and companies will make public announcements well in advance of the dividend payment date. This notice includes details such as the dividend payout ratio, the amount of the dividend, the ex-dividend date, the date the stock becomes ex-dividend, and the actual payment date when cash is distributed to shareholders. Dividend announcements create positive hype around the stock as investors look to reap short-term gains by owning the stock before the ex-dividend date. As a result of this strong demand, the stock price shoots up. Buyers are willing to pay a premium price because they know they will receive a dividend. Swing traders invest in shares of firms that have just declared or are expected to pay a dividend, then cash in on the subsequent price increase caused by the dividend goes ex-dividend.
Some examples of dividend rallies include:
● Listed company Vedanta announced a massive interim dividend of 1300% of the par value (Rs 13 per share) and the stock rose 1.6% on the day of the announcement.
● In 2021, BPCL, another company known for distributing attractive dividends, came up with Rs. 58 dividends per share. On the day of the announcement, the stock price climbed 2.5%.
The Circumstances of Falling Stock Price Post Ex-Dividend Date:
Buyers who purchase shares before the ex-dividend date are eligible for the dividend, and those who purchase shares on or after the ex-dividend date are considered ineligible. When buyers show little interest in the stock's current market price and offer lower prices, sellers are automatically forced to lower their asking prices, leading to selling pressure on the stock. Additionally, buyers who purchased the stock purely to receive the dividend will start selling the stock once the stock goes ex-dividend. Even if they sell shares after the ex-dividend date, they will still be entitled to dividends. The general trend has been for stock prices to fall when a stock goes ex-dividend, which is pretty much a dividend payment - the dividend price roughly adjusts to the stock price.
For example, in the above BPCL case, where the company issued a dividend of Rs. 58 per share, the ex-dividend date was set for September 16, 2021. In the following 4 trading sessions, the stock experienced what we call a "dividend adjustment"; down from its high of Rs. 495 registered on 15 September 2021 at Rs. 413. This sale could be mainly associated with buyers who dumped the shares on the ex-dividend date.
Conclusion:
Although stock dividends may not result in any real increase in value for investors when dividends are issued, they affect the price of any stock in a way that resembles cash dividends. When a stock dividend is declared, the price goes up, and this could have several implications for new investors who want to buy new shares or sell shares they already own. However, since a stock dividend results in an increase in the number of shares outstanding while the value of the company remains stable, it is prone to diluting the book value based on the common stock. Accordingly, the share price may be reduced. General dividend market behavior involves a stock price rising near the dividend announcement date and falling once the stock goes ex-dividend. However, there is no hard and fast rule that the same should be followed every time.
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