[dpifke]

Paying out cash on hand should reduce the share price, because money in the bank is proportionally owned by the shareholders.

For an extreme example, imagine a hypothetical company with 1 billion shares outstanding and $1B in the bank and no other business than earning interest on its cash. With $1B in the bank, it should be valued at $1/share plus some share of expected future interest payments. Pay out a $1/share dividend, and the company is now worth $0.

[jagjit]

Hmmmmm. This would explain it - but for the fact that dividends are generally supposed to be paid out of profits not out of cash in the bank. Aren't dividends a way of sharing profits with shareholders, not sharing the net worth of the company. If a company is not making any profits, it should not pay any dividends.

Your hypothetical example though is a very useful way of understanding these things. Infact it just helped me understand clearly why companies should keep as little cash as possible - unless they can generate returns better than atleast govt bonds.

[sokoloff]

You're making a distinction without a difference.

If not paid as a dividend, where else would that profit go but to cash in the bank at time T+1? (Technically, it's free cash flow that goes to cash in the bank, but the difference isn't meaningful here.)

[dschobel]

Huh? share price is determined by one thing and one thing only, market demand.

As twitter has shown, valuation does not need to correlate to any traditional financial metric whatsoever. Twitter is worth 1 Bn becomes someone decided to pay for a stake at that valuation. No other reason.

[Super_Jambo]

Sure, but the fundamental value of the share obviously goes down at the instant the company pays out a dividend, so the expectation is that the companies price will drop.

Since everyone expects it to happen it generally does.

[dschobel]

Except that dividends are announced well in advance so if the price did drop automatically on the day the cash is paid out, it would be trivial to short the position.

The fact is, there is nothing predictable in the stock market.

edit: as BobbyH points out, my point about shorting is mistaken but that does not change the key point about unpredictability of the markets vis a vis declaring a dividend.

[andrew1]

A good example of dividend behaviour can be seen in the 16th December dividend from Sycamore Networks (see http://www.google.com/finance?q=scmr). This dividend was announced on the 18th November (roughly a month before the effective date). The share price doesn't change at that point, but on the effective date it falls by $9.70, almost exactly the dividend amount of $10. I chose this example as Sycamore gave out a quite ludicrous amount of cash (something like 35% of the company value) so the price drop is very obvious. Another unusual feature of the dividend is that the pay date is actually before the effective date. The dividend is paid on the 15th December, even though its the people who own the shares at the market open on the 16th who qualify for the dividend. This comes about due to a rule that NASDAQ have that if a distribution is greater than 25% of a company value, then the effective date is set to be the day after the pay date.

I think that while there is a lot that is unpredictable about the stock market, you can be fairly sure that on a dividend's effective date, the share price will fall by roughly the amount of the dividend. It won't be exact due to all the other factors which would affect a stock's price on any day, but it will be roughly correct.

[BobbyH]

dschobel, when you short a stock, YOU are responsible for paying the dividend to the person you borrowed it from, c.f. http://en.wikipedia.org/wiki/Short_%28finance%29

That's why investors can't make an infinite amount of money by shorting stocks right prior to the dividend date...

[elblanco]

Right, it's like the late night infomercials that sell various stuffs....usually with a 2-for-1 offer at the end of the commercial and a discount...all followed by a statement "A 120 dollar value! Yours for $19.99"

[joshu]

Twitter is not liquidly traded on a market and thus not useful for this argument.

[dschobel]

Fine, so then take GOOG which by all traditional metric (EPS, etc) would be grossly over-valued.

You guys really get tripped up in irrelevant minutiae...

[joshu]

If you are fuzzy with details it implies you are fuzzy with reasoning.