Aren't dividends meaningless since the price of the stock goes down anyway on the Ex-Date?

Question

Aren't dividends meaningless since the price of the stock goes down anyway on the Ex-Date? As far as your absolute balance is concerned, there's no change: Portfolio down by the amount of the dividend being distributed while your cash balance is up a few days later by the same amount.

Answer 1

Your argument is exactly the one used by Modigliani & Miller in the late 1950s. They got the Nobel prize for their theories.

Despite what others here say, you do see a drop in price on Ex-Dividend day. It is not exactly equal to the difference in price -- because it reflects the tax situation as well. Those who say that the stock bounces back to the old price after a few days are misinformed and unfamiliar with academic research in the field.

The truth is that, on average, when a company that does not pay dividends starts paying them -- it has an abnormal and permanent jump in price of about 3% to 4%. Why does the market reward companies that pay dividends?

Miller & Rock suggested (in their landmark paper in the early 1980s) that companies can send information to the market about their quality by starting to pay dividends. Companies can say "We are so good at what we do that we can afford to give you back some money and still do well." This signalling of quality is strong enough to bring up the stock price. In addition, it usually signals the fact that the company has left the growth stage and has become a more mature company. This is usually accompanied by both dividends and a lower volatility.

The market tends to punish firms that stop paying dividends by slashing their prices. Therefore, a company will not pay dividends unless they can commit to paying them for a long time. This committment is what sends the strong signal to the public.

Other theories (Jensen, in particular) suggest that if a company is paying dividends, it won't have a lot of extra cash lying around. He believes that if there is too much extra cash, then people would waste it. If they pay it back to investors, it is harder for companies to be wasteful.

Answer 2

You are VERY mistaken, and apparently misunderstand the nature of dividends completely! Sorry!

Literally millions of people live on the dividend income from their stock portfolios, and while a stocks price may experience a temporary blip around the dividend date, if what you think you see was true, a $40 stock with a $1 quarterly dividend would be whittled away to $0 in ten years, which simply isn't what happens!

Dividends are paid out of earnings.

A stock's price is determined by market sentiment.

There is no "mechanical" link between the two!

Answer 3

What your failing to see is the fact that the stock continues to trade and usually within a day or two if not the same day, the amount of the dividend that reduced the price of the stock has already been made up by the stock rising in value, and you have pocketed the dividend.

With your thinking, if the amount of the dividend always reduced the price of the stock, without any potential rise in the price of the stock, most stocks would be trading for pennies.

Answer 4

i like dividends, but simply i can use them to reduce my income tax..