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If you have ever freaked out when your share price dipped after your stock went XD, this article is for you.
In this installment of the #AskDrWealth series, we are going to unravel that mystery for you.
We'll be breaking down the dividend distribution process, giving you the differences between cum dividend and ex dividend, and explain why you shouldn't freak out (or invest) when prices dip during XD.
Let's get into it:
What is a Dividend?
Before anything else, let us establish a common understanding of what a dividend is.
A dividend is basically the distribution of a portion of a company’s earnings. It is probably the best benefits you can get from owning a prosperous business as a shareholder.
Dividend payout amounts are decided by the board of directors and can be issued in the form of cash payments, as shares of stock, or other property.
Will there be a Dividend Payout?
Companies decide on the frequency of their dividend distribution.
Some companies (like REITs) may pay dividends quarterly, some may payout half-yearly and others, or not most companies will only distribute once a year.
A company will typically announce their Quarterly, Half-yearly or Yearly results.
If the results are not good, the company management may decide not to distribute any dividends. 🙁
But if the results are good, it is likely that the management will distribute or declare a particular dividend.
When this happens, a series of dates will be announced by the management of the following:
- Cum Dividend
- Ex Dividend
- Pay Out!
What do these three different stages mean?
Let's break it down below:
First, let us make sure we're all of the same understanding...
Definition of Cum Dividend:
Cum Dividend is the status of a stock when the company is preparing to pay out dividend in the near future.
So basically, a dividend is declared, but is not paid.
The 'cum dividend' status is like a notice to investors. The company would be announcing the amount of dividend that will be paid out soon.
If the shareholder sells a "cum-dividend" stock, he/she will not be entitled to the dividend.
Now, let's assume you're holding onto the stock and you decided to sell the stock during the cum dividend ('CD') period.
'Cum dividend' means 'along side' or 'with' dividend. This literally means if you own the stock during this period, you will get the dividends.
Scenario 1: If you sell your stock during CD
Once the stock is sold during the CD period, you are no longer entitled to the dividend and hence, will NOT receive any dividends.
Scenario 2: If you bought the stock during CD
If you don't have the stock and you decided that you want to invest in it during the cum dividend period, you will be entitled for the upcoming dividend payout.
It is as simple as:
- If you buy during CD, you get the dividend.
- If you sell the stock during CD, you actually don't get the dividends.
After the cum dividend date, the stock will move to the ex dividend date or 'XD' in short.
Definition of Ex Dividend:
Ex Dividend is the status of a stock when the company has confirmed the list of shareholders to receive the dividend. It is the classification of trading shares when a declared dividend belongs to the seller rather than the buyer.
Once the company has finalized their list and declared the XD status, the list of shareholders entitled to the dividends will be 'locked in' and no further changes can be made.
So ex dividend would be the reverse of cum dividend. Which means, if you buy a stock during this date or XD period, you would be excluded from receiving the dividend.
Scenario 1: If you sell your stock during XD
The shareholder who sells his/her shares during this period will still be entitled the dividends, while the new owners will not.
Scenario 2: If you bought the stock during CD
The investor who decides to invest into this stock during the ex dividend date will receive no dividends.
As a quick summary:
- If you buy during XD, you will NOT get the dividend.
- If you sell the stock during XD, you get the dividends.
Why Does the Price Share Drop During the XD?
Following our train of thought from the previous section, it is no coincidence that during the XD date, you'll notice that the share price will drop.
Theoretically, this dip would be equivalent to the amount of dividend per share that is declared to be distributed.
The reason is that when a dividend has been distributed, the cash level in the company decreases. And so, the value of the company also decreases. The share price then reflects this drop in the fundamental value of the company.
It is only fair that the existing shareholders get less value when selling their shares and that the new shareholders would also buy in at a cheaper price, because the value of the company has dropped.
On the XD day, you won't receive your cash just yet, even though they recognized who will receive the dividends.
It is only a few days later on the “pay date” that the actual dividend cash is being transferred from the company to your bank account.
However, you might not receive the dividends punctually on the pay date either. It will depend on the timing and process of the banking transaction.
But you should definitely see it in the next few days.
That is it for this session of the #AskDrWealth series.
I hope you have a better understanding of the dividend distribution process, as well as an understanding of the implications of cum dividend and ex dividend.
Hopefully the next time you see the price drop during ex dividend, you'll not freak out!
Co-Founder. Believer of the Factor-based Investing approach. Running a Multi-Factor Portfolio that taps on the Value, Size, Profitability and Momentum Factors. Quant at heart. Believe the financial industry can treat their customers better. Wants to change the world.