At its core, a share signifies partial ownership in a company’s future profits and assets. Companies typically have three primary methods to utilize surplus cash flows:
- Reinvest those profits back into the business.
- Return profits in the form of a dividend.
- Return profits through a buyback.
In this article, we will focus on dividends, exploring how their payment affects share prices and identifying the types of companies that are more likely to distribute dividends.
Chart 1: A company’s aim is to earn profits, which they can reinvest or return to shareholders
Dividends reduce a company’s assets — that should impact prices too
While a share represents ownership in future profits, paying a dividend reduces a company’s net assets by the amount of the dividend. This raises an important question: How does paying a dividend influence the company’s value and stock price?
Getting to ex-date
When a company pays a dividend, several key dates come into play, as illustrated in Chart 2. The ex-dividend date (ex-date) is crucial for investors, as it marks the cutoff for receiving the upcoming dividend. On this date, the share price adjusts to reflect the dividend payment.
In summary, an investor buying the stock:
- Before the ex-date will be settled and “on record” to receive the dividend.
- On or after the ex-date will not be on record in time, thus missing the dividend.
Chart 2: Dividend timeline
Investors who buy prior to the ex-date must wait until the actual pay date to receive their cash dividends. This waiting period can create “cash drag” in a portfolio, especially if the market appreciates while waiting for the cash, as it cannot be reinvested without leveraging the fund.
Many professional investors mitigate this by using futures to cover cash accruals, allowing them to maintain broad stock market exposure without requiring cash settlement.
What happens when a stock pays a dividend?
In theory, an investor should pay less for a stock that does not offer a dividend compared to one that does. Since dividends are paid in cash, the valuation difference is straightforward. Intuitively, a stock should drop by the exact amount of the dividend when it goes ex-dividend.
- The opening trade of ex-date is the first time the stock trades without the right to receive the upcoming dividend.
- The closing trade before is the last time the stock trades with the right to receive the upcoming dividend.
- Comparing the opening price to the prior closing price provides the most accurate estimate of the dividend’s impact.
For example, we can visualize the ex-dividend impact on PepsiCo’s (PEP) stock around its December 2024 ex-date. The price of PEP indeed fell overnight as it went ex-dividend (blue line in Chart 3).
Chart 3: PepsiCo (PEP) vs. Coca-Cola (KO) on Dec. 6, 2024
In this instance, we observe the price reaction of Pepsi’s stock (PEP, blue line) around the ex-date:
- The ex-date is Dec. 6, with a dividend payable of $1.35 per share.
- The stock price fell from $160.49 (at the end of Dec. 5) to $159.35 (at the start of Dec. 6).
- This represents a drop of $1.14 ($0.21 less than the dividend).
- The return, including the dividend ($0.21), equates to a positive return of 0.13%.
Market news, company updates, and shifts in sentiment can significantly influence overnight performance, leading to variations in price adjustments beyond the dividend amount.
Next, we ask: Was there positive news that contributed to the 21-cent difference? Given that PepsiCo and Coca-Cola operate in the same industry and typically exhibit a high positive correlation (~0.70), we can compare KO to PEP to control for the ex-dividend impact.
The fact that KO (red line) traded higher between the close on Dec. 5 and the open on Dec. 6 suggests some positive sentiment or news about the industry. In fact, KO was up around 0.30% in the pre-market session before opening flat.
Both KO and PEP experienced positive overnight returns of a similar magnitude (after including the dividend), indicating that the “real” price adjustment was likely close to the dividend amount.
Does the market always discount the whole dividend on ex-date?
By analyzing the adjusted overnight return against the dividend paid for all U.S. large-cap equity securities over the past five years (January 2020 through December 2024), we observe the following on ex-dividend dates:
- Many stocks see their prices fall by roughly the value of their dividend.
- The median stock declines by only around 90% of its dividend amount.
- The most likely outcome is a drop even less than that.
- Approximately 20% of stocks see prices increase on ex-dividend dates, even after accounting for overnight market movements (grey zone in Chart 4).
Chart 4: Distribution of ex-dividend price reactions (U.S. large caps)
Some stocks may experience a drop greater than the dividend amount, indicating that various factors can influence overnight price changes.
What types of companies pay dividends?
Not all companies distribute dividends. Companies with promising growth opportunities often reinvest cash flows instead. Data shows that larger, more mature companies are more likely to pay dividends (Chart 5). Similarly, value-oriented companies—characterized by stronger earnings yields and lower growth rates—tend to distribute dividends.
Chart 5: Characteristics of dividend-paying stocks
Companies in defensive industries, such as utilities, financials, materials, and staples, are more likely to pay dividends compared to those in sectors like technology, healthcare, or telecommunications (Chart 6). However, this does not always translate to a higher dividend yield, as the highest yields often come from real estate, utilities, and telecoms.
Chart 6: Dividend-paying stocks across industry
Investors seeking a regular income stream are more likely to prioritize dividends, while those focused on growth may need to accept primarily price appreciation and capital gains. Regardless, keeping track of ex-dates is essential for all investors. An abrupt price drop on the ex-date may not necessarily be negative; it could simply reflect the dividend adjustment.
