About Dividends and ex-Dividends

One of my investment strategies is to buy companies that pay dividends (i.e. dividend paying stocks). In conjunction with my recent post about dividend yields, I want to also discuss the mechanics of dividends. Basically, stocks could be classified into two categories: those that pay dividends, and those that don't. A lot of smaller, growth companies do not pay a dividend. Companies are not required to pay dividends, and each dividend must be declared by the company (usually at a board of directors meeting) before it is paid. An example of a big company that does not pay a dividend is Berkshire Hathaway (NYSE: BRK-A and BRK-B).

In the United States, most companies that pay a regular dividend do so every quarter. There are exceptions, for example some companies pay their dividends only once or twice a year. When looking at a finance site such as Yahoo Finance, the dividend is listed with the company stock quote. I estimate that 95% of the time this data is correct. However, sometimes it is inaccurate or outdated, so it is a good idea to confirm this information with another source.

Typically, when dividends are announced, the company will usually issue a press release that says something like this:

The board of directors of Pfizer Inc (NYSE: PFE) today declared a 16-cent fourth-quarter 2009 dividend on the company’s common stock, payable December 1, 2009, to shareholders of record at the close of business on November 6, 2009.

Let's dissect this statement. For 2009, Pfizer (NYSE: PFE) paid dividends of 16 cents per quarter (equivalent to 64 cents for the year). The dividend was paid on December 1 to "shareholders of record" on November 6. In order to be a "shareholder of record" one has to own the stock 3 business days before the record date. In this case, that date is November 3. On November 4, the stock goes "ex-dividend". What that means is that if you buy the stock on November 4 or later, you are not entitled to this particular 16-cent dividend. The term "ex-" in this case means "without". So as of November 4, the stock trades without the current dividend.

A common question about dividends is "What happens if you sell the stock on November 4 or later, but before the December 1 date when dividends are paid?" In this case, you would be entitled to the dividend, even though you don't own the stock on the pay date. This has happened to me several times where I've received dividends on stock that I no longer own.

Another more involved question that people sometimes ask is "What if you bought the stock on November 3 and sold the stock on November 4. Does that qualify you as a "shareholder of record" for November 6?"

Looking at a calendar, if you buy the stock on Tuesday, November 3 (trade date), it will show up in your account on the morning of Friday, November 6 (settlement date). On the settlement date, the brokerage deducts cash from your sweep account in exchange for the stock. If you sell the stock on Wednesday, November 4, the sale will settle in your account on the following Monday, Nov 9.

In this example, you are the "shareholder of record" from the morning of Nov 6 until the morning of Nov 9. This sounds strange because you have already traded away the stock. Nevertheless, you "own" the stock at the close of business of Nov 6, so you are entitled to the dividend. Some investors actually use this method, which is known as a "dividend capture" strategy, to invest in stocks.

PFS