March 27, 2011

Do Stock Values Drop After Dividend Payouts?

Have you ever seen someone make the following kind of statement? :

After a stock pays out the dividend the market value of the stock will drop by that same amount the day the dividend is paid out.   For example :  ABC corp trades at $20 and pays out a $0.50 quarterly dividend the day the stock pays the 50¢ dividend the shares will drop by the same 50¢ amount down to $19.50.     The market may cause the stock to go up or down which would otherwise hide this effect.

The above statement is not a direct quote but a paraphrased version of what I've seen several people say.    I actually only heard this for the first time myself recently (probably within the past 6 months?).   When I first heard this I thought to myself  : "Oh, huh, I didn't know that."    I tried to verify it by looking at the value of stocks but when you look at a company that pays a 10¢ dividend and the price of the stock bounces up and down +/- 50¢ in a given day its impossible to differentiate the impact of that 10¢ dividend from other daily market movements.

For example lets look at GE historical prices..
On Feb. 23, 2011 the stock closed at $20.37.   They then paid a dividend of 14¢.    It opened at $20.12 on Feb. 24th.    Thats $0.25 lower than the close price which might include that 14¢ dividend.   The stock was down more than 14¢.

But back on Feb 18th GE closed at $21.44 and then opened on Monday Feb 22nd at $20.88.   So the difference between closing on Friday and opening on Monday was down $0.66.   With that kind of swing between close on one day and open on another its hard to see the impact of a 14¢ dividend.

But a 14¢ dividend is less than 1% of the market value of GE and the day to day volatility can easily be more than 1%.   In order to see the phenomenon better it would be best to find a company that pays out a really big dividend that is not easily confused with the market volatility.    If the dividend is 0.7% and the market goes up or down 0.5 to 1% daily then you'll never really see the impact of that 0.7%.     Lets look at the change in market value from close to open in GE stock on a daily basis.  I've highlighted the dividend dates in yellow:

As you can see the yellow dividend dates are just buried in the noise of the normal market fluctuations for GE stock.  So its impossible to see any real pattern from the dividend payouts.

What you need is a stock that pays out a large dividend that might cause a drop that is much larger and clearly not a result of typical market fluctuations. If a company has a very large dividend of say 5% then its a lot easier to see the impact.    Its pretty rare to find a company that pays out such a high dividend rate. 
I was able to find a company with a very large dividend : American Capital Agency Corp. (AGNC).   Their dividend is $1.40 per quarter and they are trading around $28 lately.   So their quarterly dividend is pretty close to 5% of the stocks market value.     Plus they've been paying that $1.40 dividend for 7 quarters straight so it would be easy to see some history.  

Here is how the stock closed and opened around dividend payouts for AGNC in the past 7 quarters :

close open diff
3/18/11 $30.67 $29.50 $1.17
12/28/10 $29.57 $28.29 $1.28
9/23/10 $29.27 $27.90 $1.37
6/25/10 $28.97 $27.20 $1.77
3/26/09 $27.70 $26.45 $1.25
12/29/09 $28.49 $27.01 $1.48
9/29/09 $30.28 $28.55 $1.73

The day after the dividend pay out the stock opened down between $1.17 and $1.77.   Thats a big change and not far from the $1.40 dividend on average.  How does that compare to the normal daily fluctuations in the market value of AGNC?     In that same period the stock was changed more than $1 between close and open only 13 times total and 7 of those were the day after dividend payments.  and Lets look at it graphically again :

Again the dividend dates are in yellow.   This time its much more obvious that the dividend dates are causing the stock to drop significantly.   The drop is also clearly not normal for the daily market fluctuations for AGNC.

I think this is pretty evident if you look at a large dividend.    Yes the stock values do drop after dividend payouts.  

Now that I've been able to successfully see the effect for myself I'll go ahead and get another opinion.   The Motley Fool says this :

"The exchanges often, though not always, adjust the trading price downward by the amount of the dividend on the ex-div date. For most dividends, this adjustment is lost in the noise of the day's trading. For large dividends, on a historic price chart, it can look like a sudden drastic drop. For instance, on Jan. 25, 2006, TDAmeritrade's stock opened $6.44 lower than it had closed the night before. Six dollars of that drop was due to the adjustment for a special dividend."

So they confirm it and give another good example with that $6 special dividend by TD Ameritrade (AMTD).  But there is one detail in that quote from Motley Fool to take note of.   They say that the ""The exchanges often, though not always, adjust the trading price..."    I would interpret that to mean that some exchanges may not do it.  But Motley Fool doesn't go into specifics. 

Whats this all mean?    Well dividends aren't just free money windfalls that come out of thin air.  The dividend is subtracted from the stock price and paid out in cash.   Most stocks pay lower dividends and the dividend adjustment will not be easily visible due to market volatility.   But the reduction in market value is there and much more easily seen in examples of dividends that are larger compared to the market value of the stock.  

Does this mean dividend paying stocks are bad investments?   Oh, no not at all.   Many dividend paying stocks are great investments.   But you should be aware that the dividend payout reduces the market price of the stock.

Bottom Line : The market value of a stock will drop the day after the ex-dividend pay out.   This is not obvious in the market changes for stocks with smaller dividends but can be seen with examples of dividends that are a higher % of the market value. 

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