Investing in dividend paying companies is a great way to create
long-term wealth. One of the primary reasons is that the stocks of such
companies offer a dual benefit to investors by way of both regular dividend
payouts as well as share price appreciation
Did you know that the decision by a company to distribute dividends to
its equity shareholders is capable of affecting its share prices? There is a
correlation between dividends and the share prices of companies. If the
question ‘how do dividends affect stock price?’ is running on your mind right
now, here’s the answer
Concept of dividends
The equity shareholders are technically the
owners of a company. And as such, they enjoy a claim on the profits of the
company. So, when a company generates profits, it distributes it to its equity
shareholders by way of dividends.
When it comes to paying dividends, a company
need not always pay them out in cash. Companies are also allowed to pay
dividends out to its shareholders by way of allotting them fresh equity shares
of the company for free. Such a dividend payout is commonly referred to by
investors as stock dividends.
Companies don’t make dividend payouts just
because of the fact that its equity shareholders have a claim on its profits. It
does so as a way to thank its equity shareholders for believing in the company
and investing in it. In addition to that, a company also pays dividends to its
existing shareholders to encourage further investment from prospective
How does dividend
affect share price?
let’s move on to answering the question ‘how
do dividends affect stock price?’ Paying out dividends basically act as a good
indicator of the company’s financial health and success. That said, here are
some pointers that clearly show how dividends affect stock prices.
Dividend paying companies enjoy favourable
Although equity shareholders enjoy a claim
over the profits of the company, they however, lack the right over the
distribution of such profits via dividends. In spite of the fact that these
shareholders are not guaranteed dividends, many well established companies have
made it a habit to regularly and consistently distribute the profits that they
This creates a perception of stability in the
financials and enhances the goodwill and brand value of the company. Investors
tend to view such entities in a far more favourable manner than other entities
that don’t distribute dividends as often. This consistent dividend paying
mechanism of such companies tends to attract even more investors, thereby
creating demand for the stock.
However, there’s another side to this coin. A
company that pays dividends irregularly or at a rate that’s lower than usual
tends to attract negative public sentiment. This is because investors view such
companies as being financially volatile, thereby putting off the entry of new investors
and causing the exit of some existing shareholders.
leads to an increase in the share price
A company, before distributing the dividend
out to its shareholders, first makes a public declaration. This declaration
includes essential details such as the dividend amount, the record date, the ex
dividend date, and the date on which the dividend is likely to get credited to
all the equity shareholders of the company.
Such a public declaration has the effect of
increasing the public sentiment for the company’s stock in a positive manner. This
would inevitably lead to more investors purchasing the stock.
The share price drops
down on the ex dividend date
the share price that rose when the company
declared the dividend would automatically correct itself on the ex dividend
date. This is primarily because of the fact that any new buyers of the
company’s stock on or after the ex dividend date would automatically become
ineligible for receiving dividends.
And since the new buyers would not be getting
any dividend benefit by purchasing the company’s shares, they would generally
be unwilling to pay a huge premium for the shares. Since the buyers would start
quoting lower prices for the shares of the company, the sellers would be forced
to drop their asking price as well, leading to a drop in the company’s stock
Concept of ‘dividend payout ratio’ that has
the potential to affect the share prices of dividend paying companies. For
instance, if a company’s dividend payout ratio (DPR) is too high, the chances
of sustaining consistent dividend payouts become low since the company is
paying out high dividends. This can end up working against the company as it
creates a negative sentiment on the stock, thereby lowering the share price.
On a similar note, a low dividend payout ratio
essentially means that the company is paying out too little dividends. Again,
this can also negatively affect the share price of a stock. Only companies that
have a stable and moderate dividend payout ratios get to enjoy positive
investor sentiment and higher share prices.
Name- Hardik Gujarathi
SRN - WRO0551228