Understanding Dividend Dates

Understanding Dividend Dates

Dividend dates can be very confusing. A great many stock investors do not understand them at all and other investors are under the faulty influence of many popular misconceptions. The following explanation will simplify the technical language of the rules that govern dividend dates and in the process clear up the popular misconceptions. It will also provide links to several stock exchange Web sites so readers can see the official technical language for themselves.

For the sake of convenience, a list of definitions pertaining to dividend dates are provided in the column to the left of this text.

Contrary to popular belief, dividends and distributions are not the same thing. Generally speaking, a dividend is a payment of earnings to shareholders, while a distribution is the payment of stock, rights, or cash that is not from company earnings. For example, the payment of a corporate liquidation is a distribution, not a dividend, because it represents the proceeds of the sale of the company, not corporate profits. However, because dividends and distributions are subject to the same date rules by the stock exchanges, for the purposes of this discussion, dividend and distribution shall be synonymous.

There are two types of dividends recognized by the exchanges, the difference being the relative size of the distribution. Normal dividends are those that amount to less than 25% of a company's stock price. Normal dividends represent over 99% of all dividends paid, and as a result are the only ones most stock investors are familiar with. Dividends of 25% or more of a company's stock price represent a fraction of one percent of all dividends paid and are handled quite differently from normal dividends.

Normal Dividends

There are four dates related to the payment of a dividend/distribution, and without an understanding of each, the process can be very confusing. The four dates are:

1. Declaration Date
This is the date the company declares the dividend.

2. Record Date

This is the day a buyer of a stock becomes the registered owner; also called the Owner of Record. The buyer of a stock must be on the company's books as the Owner of Record to receive a normal dividend. The company itself sets this date. Because of the T+3 settlement rule, stock trades must be settled in three business days, meaning that to be an Owner of Record, a buyer of the stock must buy the stock three business days before the record date.

Contrary to a common misperception, the record date does not always determine which investor (the buyer or the seller) gets the dividend. It is true that with normal dividends the record date determines the ex-dividend date but that is not true for dividends of 25% or more of a company's stock price. Therefore, while it is often true that the record date determines which investor gets the dividend (indirectly by virtue of determining the ex-dividend date), it is always true that the ex-dividend date determines which investor (the buyer or the seller) gets the dividend.

3. Payment Date
This is when the dividend payment will be made. It is also set by the company.

4. Ex-Dividend Date
This is the only date of the four that directly affects investors, as it determines when the right to a dividend is no longer transferred with the sale of a stock. For this reason, it's also the date that causes all the confusion.

Contrary to another common misperception, the ex-dividend date is not set by the company. It is set by the stock exchange the company's stock is traded on.

To understand why it is the stock exchange and not the company that sets the ex-dividend date we have to first understand the process. If a company declares Thursday, the 7th, as the record date, an investor would normally have to buy the stock on Monday, the 4th, to qualify for the dividend because of the T+3 rule, which states that stock transactions must settle in three business days. (Settle meaning the payment must be delivered to the seller and the security must be delivered to the buyer.) From Monday, the 4th, count three business days to the settlement date (which is also the record date). Tuesday, the 5th, is one day; Wednesday, the 6th, is two days; and Thursday, the 7th, is three days.

Since Monday is the last day to buy the stock and qualify for the dividend, the next business day, Tuesday, is therefore the ex-dividend date. (Ex-dividend means without the dividend. )

If it's that simple, then why doesn't the company set the ex-dividend date? Because if the exchange is closed on any one of the three days immediately prior to the record date (in this example Monday, Tuesday, or Wednesday), then there are not three business days between Monday and the record date of Thursday. For example, if Monday is an exchange holiday, then the last day to buy the stock and qualify for the dividend would be the previous Friday, the 1st.

Only the exchanges can determine which days they are open, and therefore which days are business days (trading days) applicable to the determination of the ex-date in the case of normal distributions. That is why the exchange, not the company, sets the ex-dividend date.

The most reliable source for a dividend record date is the press release from the company itself announcing the declaration of the dividend. The press release will typically include the declaration date, the record date, and the payment date. Only rarely will it include the ex-dividend date, and when it does, it will have been established by the rules of the stock exchange, not arbitrarily by the company.

Knowing the record date, determining the ex-dividend date is straightforward. To determine the ex-dividend date, simply count back two business days from the record date. Once again using the previous example, the record date is Thursday, the 7th, so the ex-dividend date is Tuesday, the 5th.

The last day to buy the stock and qualify for the dividend is Monday, the 4th, the ex-dividend date is Tuesday, the 5th, and the record date is Thursday, the 7th.

But when counting back two days from the record date to determine the ex-dividend date, be careful of weekends and holidays! If the record date is Tuesday the 5th, the ex-dividend date is Friday the 1st, not Sunday the 7th. If the record date is Friday, December 26th, the ex-dividend date is Tuesday, December 23, not Wednesday, December 24th, because Christmas is not a business day. (Also, for foreign stocks, be aware of the holidays of the country in which the stock is primarily traded. For example, in Canada and Great Britain December 26 is Boxing Day, so would not be counted as a business day in those countries.)

To receive the dividend, you must purchase the stock before the close of trading on the day before the ex-dividend date. The trade then settles, meaning the payment is delivered in exchange for the securities, three business days later, on the record date, and you become the owner of record.

Therefore, if you buy on the ex-dividend date, you won't get the dividend because the trade will not settle until one business day after the record date. Remember, ex-dividend means without dividend.

Conversely, if you sell either on or after the ex-dividend date, you will still receive the dividend because that transaction will not settle until after the record date.

Many investors wrongly believe you must hold the stock until the record date or payment date before selling in order to receive the dividend. That is not true. It is the ex-dividend date that determines which investor, the buyer or the seller, receives the dividend.

Dividends are Not Free Money

Another common misconception is that a dividend is free money. Many uninformed investors scramble to get into a stock before the ex-dividend date in the mistaken belief that they will somehow end up ahead for having done so. This is not true because on the ex-dividend date the previous day's closing price will be reduced by the amount of the divdend. This is because the rights to the dividend are no longer transferred with the sale of the stock and since the payment of the dividend has reduced the net value of the company by the same amount, the net value of a share of stock is proportionally less. For example, a stock that pays a dividend of fifty cents per quarter and trades at $10.00 on the last trade of the day before the ex-dividend date will then have that closing price adjusted down at the open the next trading day (the ex-dividend date) to $9.50. The fifty cent dividend is no longer available to buyers on the ex-dividend date, so that amount is deducted from the stock's price. Theoretically, and indeed commonly in practice, the stock will not open at exactly $9.50, because market forces may drive the price higher or lower, but in any case, the dividend-adjusted price of $9.50 will remain as the basis upon which the daily change is calculated. If, for example, the opening price is $9.00, the daily change at that point will be down $.50. Indeed the price is a full dollar less than the closing price of the previous day, but because of the adjustment for the dividend, in reality the value has changed only fifty cents.

In addition, at the open on the ex-dividend date, all open orders will be automatically adjusted down by the amount of the dividend unless they have been placed with a Do Not Reduce restriction.

So, buying a stock before the ex-dividend date simply to capitalize on the (false) idea that a dividend is free money is nothing more than a beginner's mistake.

For a quick review, there are three important things to remember:

The record date is not the same as the ex-dividend date.

The ex-dividend date is the first day a stock trades without the right to the dividend.

Any day the stock exchanges are closed is not a business day for purposes of calculating ex-dividend dates.

Finally, to add to the confusion of record and ex-dividend dates, there are some rare cases involving unusually large dividends, rights offerings, stock spin-offs, etc., where the above rules are not followed. In such cases, the stock trades with due bills after the record date. While not a common occurrence, a stock trading with due bills is something to be aware of, and that is explained in the following section.

Dividends of 25% or More of a
Company's Stock Price

Dividends of 25% or more of a company's stock price represent a fraction of one percent of all dividends paid and are handled quite differently from normal dividends. There are some similarities, however. Like normal dividends, unusually large dividends have a declaration date, a record date, an ex-dividend date and a payment date. Also, like normal dividends, the ex-dividend date for a dividend of 25% or more of a company's stock price is set by the exchange, not the company. Here's the big (and confusing) difference: While the ex-dividend date is indeed set by the exchange, it occurs not before the record date, but after. In fact, the ex-dividend date is not even before the payment date! By rule, the ex-dividend date is one business day after the payment date. (In such cases the term deferred ex-date applies.)

Here's the exact quote from the New York Stock Exchange Listed Company Manual: "When the distribution is 25% or more, the Exchange will defer trading the security "ex" until one day after the mail date for the distribution."

And Nasdaq Rule 11140(b)(2) states: "In respect to cash dividends or distributions, stock dividends and/or splits, and the distribution of warrants, which are 25% or greater of the value of the subject security, the ex-dividend date shall be the first business day following the payable date."

Although the wording is slightly different, the meaning is the same.

This can be very confusing, having the ex-dividend date after the payment date. To further confuse things, in such circumstances, any shareholders of record who sell their shares before a deferred ex-dividend date also sell the right to receive the dividend. This is not optional to the seller, it is mandatory. The right to receive the dividend is contained in an attachment to the sold shares and that attachment is called a due bill.

The payment of a dividend via due bills is quite unlike a normal dividend payment. Shares that are purchased after the record date but before the deferred ex-date (the due bill period) are traded with a due bill attached. The chain of events that begins on the payment date works like this: The dividend is first paid to the shareholder of record, then, on the due bill settlement date, which is commonly two trading days after the ex-date, the dividend is withdrawn from the account of the shareholder of record who sold the shares during the due bill period and is then paid to the shareholder who bought the shares during the due bill period.

The dividend is paid to all shareholders of record first because that is the only information the company has on who is eligible for the dividend. The due bills are then executed by the stock brokerages of the buyers and sellers during the due bill period. The company does not participate in the due bill process.

A very unusual circumstance, to be sure. But there are good reasons for such a procedure.

On big percentage distributions one of the reasons the ex-date is after the payment date is to prevent the chaos that would be triggered if the the ex-date was before the payment date as is normally the case. For example, if the ex-date was before the payment date for a stock that was selling for $21 and they paid out a distribution of $7, such a dramatic drop in price could potentially, and unfairly, trigger margin calls in margin accounts holding the stock. To the stock brokerage it would appear that the total value of the stock had dropped precipitously when in reality the dividend that had not yet been paid would make up the difference. By making the dividend payment before the stock price is adjusted down on the ex-dividend date, no margin call would be issued because the value of the account would not be unfairly compromised.

Another reason for the use of due bills with extra large dividends is that it allows shareholders to receive the full value of their holdings if they choose to sell during the due bill period. Otherwise they would have to wait the days or weeks between a normal ex-dividend date and the payment date.

To summarize, in cases of a deferred ex-date, stock traded between the record date and the ex-date trades with a due bill attached that specifies that the right to the dividend is sold with the stock. With electronic trading and electronic book entry accounting, due bills are rarely seen by stock investors today but they are noted on the trade confirmation slips.

The Purpose of the Record Date

With all dividends, the record date establishes that only the shares outstanding as of that date are eligible for the dividend. With normal dividends that is a moot point because the ex-dividend date, being two business days before the record date, has already established which shares (and which shareholders) qualify for the dividend. But in the case of a dividend of 25% or more of the company's stock price, the ex-dividend date is after the record date, usually many days or weeks after, so the company may, if it chooses to do so, issue additional stock after the record date but before the ex-dividend date without affecting the gross amount of the declared dividend. While occasions of a secondary offering during such a period are rare, there are many more instances of shares being issued through dividend reinvestment plans and through exercise of stock options and convertible securities.

In the case of dividends of 25% or more of the company's stock price, the only function of the record date is to determine on which shares the dividend is paid. Because of that -- and this is a critical point -- it is the ex-dividend date that determines who qualifies for the dividend, not the record date.

While initially confusing, there are valid, rational reasons why on big percentage distributions the ex-dividend date is after the record date and after the payment date. It doesn't happen often, but big percentage distributions don't happen often. That's why most investors aren't familiar with how they work.

Summary

All the above dividend date information can be broken down to into five simple statements:

1. The record date determines which shares receive the dividend.

2. The ex-dividend date determines which shareholders receive the dividend.

3. For normal dividends, the ex-dividend date is two business days before the record date.

4. For dividends above 25% of the stock price of the company, the ex-dividend date is the first business day after the payment date.

5. Dividends are not free money - the price of the stock is reduced by the amount of the dividend at the open of trading on the ex-dividend date.