How do dividends affect stock prices?

How do dividends affect stock prices?

Dividend history often finds a spot in every seasoned investor’s checklist while investing in stocks. Though dividend distribution is purely an optional financial decision of companies, it has a lot more to do with the share price than you might think. Market participants must have observed stock prices taking dividend announcements positively and slumping when the stock goes exdividend.

Still, the question that remains is how do dividends affect stock prices? We’ll look to answer that, but before that, let’s know what a dividend is.

What are dividends and what is their significance?

Dividends are rewards given to shareholders for contributing to the equity of a company. In simple terms, it is the share of profit that is distributed among the shareholders. Companies use dividends to distribute profits to their shareholders as payback to show faith in the company and encourage them to maintain their trust. Dividends themselves are a valuable addition to the company’s image because it is perceived that only those companies with a consistent track record of cultivating profits distribute dividends. That said, companies are in no way bound by any law or regulation to pay out or not pay out dividends; they have the right to either distribute their profits as dividends or reinvest them in the growth of the company.

To get an insight into whether a company is in a position to pay a dividend or not, it is important to understand a company’s financial statements. To know more, read our article on How To Read A Company Balance Sheet Before Buying A Stock on Teji Mandi blogs.

Ways in which dividend affects stock prices Investors mark their calendars for dividend notifications coming from companies having a track record of paying handsome dividends. While stock price follows a predictable pattern most of the time, you can never convincingly predict how a stock would actually react to the dividend announcement.

1. Investors prefer dividend-paying companies: Traditionally there’s been an inclination of investors towards dividend-paying counters. If I ask you to pick one of the following, what would you choose – A stock that promises decent upside potential or a stock that promises decent upside potential along with a decent dividend payout?

Obviously, a prudent person will be inclined towards dividend-paying stocks.

Companies with a stable dividend payout history are financially sound because the dividend represents a part of the company’s profits and thus is preferred for long-term investments.

Many reputed companies have made it a habit to pay out consistent dividends despite no legal liability. This further reinforces shareholders’ beliefs in the company and adds to its goodwill.

Read More About- How dividend affect stock market However, there’s a flip side to the coin; companies with irregular or declining dividend payout trends act as a red flag for the company because investors always feel safe with stocks that show stability.

Uncertainty is not liked by market participants and thus works negatively for the company.

Dividend becomes a major factor for some investors while they are looking for shares to invest in. Experts at Teji Mandi filter out stocks that best suit your financial goals and needs, as well as your risk appetite. For active advice, download the Teji Mandi App!