It continues to amaze me how many very astute investors inquire about a dividend-only stock portfolio while at the same time misunderstanding the very concept of a dividend, so I’d like to spend the next few minutes debunking some dividend myths. By definition, a dividend is a sum of money paid regularly by a company to its shareholders out of its profits. As a stockowner in a public company, you may be eligible to receive dividends if you own the stock as of the ex-dividend date.
MYTH: Dividends represent an additional return.
Here’s a brief summary of a transaction using a fictitious stock that pays a quarterly dividend of $3/share:
May 3, 2016: Stock closes at $33
May 4, 2016: Ex-dividend date. Stock closes at $30 after the dividend is declared. [In reality the stock would be higher or lower than $30 depending on how the news of the day impacted the stock price.]
If you owned 100 shares, that stock was worth $3,300 as of the close of business on May 3. The company decided that for whatever reason, it was going to return some of its profit to its shareholders. You received $3/share times 100 shares for a total of $300, which you could elect to receive in cash or have reinvested back into the company. Assuming you chose the $300 cash, your 100 shares were worth $3,000 as of May 4. If you reinvested the shares, you now own 110 shares ($300 dividend divided by $30 stock = 10 additional shares) with a total value of $3,300.
May 3, 2016: $3,300 of stock owned
May 4, 2016 (no reinvestment): 100 shares of stock at $3,000 + $300 cash = $3,300
May 4, 2016 (with reinvestment): 110 shares of stock at $3,300
At the end of this transaction, you would have no more or less value than you did prior to the ex-dividend date. Otherwise, if the dividend was “found” money, intelligent investors would simply buy all dividend-paying stocks one day before the ex-dividend date (since that date is announced ahead of time) and then sell all dividend-paying stocks one day later. In fact, a dividend is basically part of your ownership interest being returned to you. As the investor, you then have the option to take the cash and own the same number of shares of the company or reinvest it back into the company and own more shares. Studies have shown that some investors use the $300 dividend as way to control their consumption, as opposed to selling shares and spending from capital. While not rational, this may be necessary for those with a self-control problem such as impulse buying.