My idea well has run dry this week, but I do have one thing on my mind worth sussing out. Let’s talk about how the market goes about pricing in dividends.
You’ll recall there are two ways a traditional equity investor gets paid. One is through price appreciation, and two is through the payment of dividends. Cash-rich companies have several options for what to do with their hoard. They could acquire a competitor or other related company to improve synergy. They could invest in research and development to ensure their future dominance. They could buy
Thanks for Being a Shareholder!
Not all stocks pay dividends, of course, but many do. And if an ETF owns shares of companies that pay dividends, they will pass along the regular cash payments to shareholders of the fund. For example, SPY pays a dividend of $1.43 three times a year. And it’s not just stock ETF that deliver regular paydays. Bond and REIT ETFs do likewise.
It’s hard to get rookie traders excited about the dividend side of the business because we’re only talking about an extra few
“According to Professors Elroy Dimson, Paul Marsh, and Mike Staunton of London Business School, if you had invested $1 in U.S. stocks in 1900 and spent all your dividends, your stock portfolio would have grown to $198 by 2000. But if you had reinvested all your dividends, your stock portfolio would have been worth $16,797! Far from being an afterthought, dividends are the greatest force in stock investing.”
You can set
I think of dividends as a company’s way of saying, “thanks for being a shareholder! Here’s your cut of the profits.”
Now, here’s where the efficiency comes in. Dividends are priced out of the stock on the ex-dividend date. The prefix “ex” means without, as in, “the stock is now trading without its dividend.” Let’s use BIL, for example. It’s a Treasury Bill ETF that pays out monthly dividends (currently 16.5 cents)and has a yield (2.17%) somewhat comparable to what you would get investing in a 3-month treasury. Because it pays out monthly, it’s easy to see the payouts impact on BIL’s share price.
All else being equal, wouldn’t you be willing to pay 16.5 cents more for BIL on the day before the dividend is priced out? If you buy BIL on Monday, you get paid a 16.5 cent dividend for that month. If you purchase it on Tuesday, you don’t get paid a 16.5 cent dividend for the month. Doesn’t that mean BIL should trade 16.5 cheaper on Tuesday?
Answer: Yes.
And it does. Every month, BIL rises 16.5 cents ahead of the dividend and then falls 16.5 cents on the ex-dividend date. Because the value of a short-term bond doesn’t really fluctuate (like a stock would), the only thing driving the fluctuation in its share price is the monthly dividend.
The same phenomenon happens with any stock or ETF paying out dividends. It’s just not as obvious because they are paid out much less frequently, and the share prices are already jumping around due to changes in the perceived value of each company.
And, in case you were wondering, there isn’t any risk-free way to game the dividend payout. You can’t buy the stock the day before and then sell it the morning of for the same price to capture the cash payout for free. You’ll lose the dividend amount on the buy/sell of the stock while pocketing that amount in cash a few days later when the dividend arrives. It’s a wash.
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One Reply to “Tales of a Technician: Dividends and the Efficient Market”
coach Tyler:
In your opninion, are dividend stocks a worthy passive investment strategy? How many shares of exon or verizon or vlo do you need to own to get a decent return?
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