Josh Peters, Morningstar’s director of equity income strategy, demystifies the process to give us more insight into the dividend-payout cycle. Here he is in conversation with Jeremy Glaser from Morningstar.com.
How does a dividend go from being announced by a company, or approved by the board of directors, to showing up in the investor's account?
There are four key dates that people need to be aware of in a dividend-payment cycle.
Announcement date: For example, Spectra Energy Corporation (a S&P 500 company) announced a dividend on January 6. That is the announcement date or the declaration date. The board of directors had gotten together and formally approved the dividend payment to shareholders. That started the rest of the process going.
Record date: This is when the books have been closed and only the legal owners of the shares as of this date are entitled to receive that dividend. In the case of Spectra Energy, it was February 14.
Payment date: This is when the dividend is actually deposited into people's brokerage accounts or perhaps mailed to them. Spectra Energy has fixed it on March 10.
Ex-dividend date: The ex-dividend date is two business days before the record date, two market trading days before the record date. This day marks the division from a practical standpoint between being able to receive the dividend and not.
Stock trades in the U.S. take 3 days to settle (it is 2 days in India-- T+2). So if you make a trade today it's going to be three business days before your broker has actually obtained the shares from whoever sold them and move your cash over to whoever sold those shares to you. The key point here is that if you buy shares on February 12, you are no longer eligible to receive that dividend. If you bought shares on February 11, even if you were the very last trade of the day, then you are eligible to receive that dividend that's going to be paid on March 10.
(For a local example, let's look at Coal India Ltd. The announcement date was January 14, the ex-dividend date January 17, the record date January 20 and the payment date January 25).
If the price is going to fall by the amount of the dividend, doesn't that negate the value of the dividend? For new investors, should they be thinking of buying before or after that ex-dividend date?
A lot of individuals think that they can just buy the stock before the ex-dividend date, sell it on or right after the ex-dividend date, and the dividend is a freebie.
Well, there is no free lunch, and over such a short time period, the dividend is really a wash, because there is an automatic adjustment that takes place to the market price of the stock--it will drop by the exact amount of the dividend when the trading opens in the shares on that ex-dividend date.
So, if you buy the stock right before; in our example, say on February 11, the next day the stock has automatically adjusted downward and then the stock will go up or down based on market forces from there. But you haven't gotten yourself a freebie. In fact, what you've done is turned a little bit of your capital into something that looks like income. And if it's taxable, you would actually do better to wait until that ex-dividend date, buy the shares that day, pay a little bit lower price and then you start receiving dividends with the next payment.
Dividends are really about long-term periods. The way I look at it is this: In order for me to benefit from the dividend, I should have owned the shares at least as long as it took the company to earn the money necessary to pay the dividend. So, even though there are strategies out there, sometimes people talk about "dividend capture," like there is some sort of magic formula here to just print money by buying stocks to get the dividend payments and then selling right away. It doesn't work, and there's really no reason to try it. You do have to have that much longer time frame in mind.
For those long-term investors who may be holding a dividend stock for decades, should they care about this dividend payment cycle and when they are going to see it in their statement?
Well, one of the other things you're going to find in any dividend press release is how much you are actually going to get, which is certainly a useful piece of information. For Spectra Energy's first-quarter dividend, they announced a rate of $0.335 a share. That's notable for a couple of factors.
First, if you multiply that by four, that gives you the annualized dividend rate. If you own the share of stock for a whole year, and the dividend rate continues at this level, which is usually the case, then you would expect to receive a $1.34 a share in dividends. That in turn allows you to calculate the dividend yield. You divide that $1.34 by the stock's current price. Recently, the stock has been trading around $35. That gives you an annualized dividend yield of 3.8%, which you can then compare to other dividend-paying stocks or perhaps to fixed-income alternatives.
You never want to confuse the dividend yield with an interest rate on a bond that's a contractual guarantee, but it does give you a way of assessing the income return potential from dividend-paying stocks.
Secondly, my favorite part about this particular announcement is that it was an increase. The previous quarter they paid $0.305; now it's $0.335. The dividend rate has gone up by almost 10%.
Those are all very important pieces of information that help you determine what kind of income you can expect from the stock. And when you look at the series of many dividend payments over many years, see the good growth that the company has provided and should continue to provide, put that in the context of a yield, and this is how you put together a good investment case.
The text has been slightly edited to make it applicable to an Indian audience.
