X marks the spot, as the saying goes.
But for investors considering whether to buy a stock, it’s ex marks the spot—as in when a stock goes ex-dividend.
Here’s a hypothetical example of a company’s dividend cycle:
The board of directors declares a quarterly dividend of 25 cents a share that’s payable on Nov. 15, a little more than a month from now, to shareholders of record at the end of business on Nov. 1.
The ex-dividend date in that scenario would be Oct. 29, the last business day before the record date.
Why is this important?
“A purchaser of stock on the ex-date, or thereafter, is not entitled to receive the next dividend payment,” says Robert Willens, who runs a consultancy specializing in tax and accounting matters.
One investing strategy that factors this in is to buy a stock in time to get the dividend payout—or before the ex-date. But investors need to be wary of chasing dividends, and they should understand a company’s underlying fundamentals.
What’s more, investors need to be aware of the possible tax consequences of buying a stock right before the ex-date and then, having collected the dividend payment, selling it shortly thereafter. That’s because the dividend payment might not be considered qualified dividend income, in which case it could be subject to higher taxation. Qualified dividend income is eligible to be taxed as a capital gain.
As Willens explains, “The stock on which the dividend is paid must be held for more than 60 days during the 121-day period that begins on the date that is 60 days before the date on which the stock becomes ex-dividend with respect to the dividend.” In other words, someone who buys in right before the ex-date and sells soon thereafter probably won’t have a qualified dividend payment.
Dan Sotiroff, a senior analyst at Morningstar, says the ex-dividend date is “really only important if you want to make sure you are getting the next dividend payment.”
“If you are a long-term shareholder [and] planning to hold it for years and years and years, it probably doesn’t mean a whole lot to you,” he adds.
Still, there are various things to consider surrounding the ex-date.
In an email to Barron’s, Rhodri Preece, senior head of research for the professional investor group CFA Institute, points out that basic stock valuation entails valuing a discounted stream of future payments, in some cases dividends. The further out those payments are and the higher the discount rate, the lower those cash flows—including dividends—are worth in today’s dollars.
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However, Preece points out, “immediately prior to a stock’s ex-dividend date, the time period to the next dividend payment is very short” and it increases “the value of that dividend payment” and the stock.
But once the stock goes ex-dividend, he adds, the next dividend payment is possibly three, six, or 12 months away. As a result, that future dividend “is more heavily discounted than the old” dividend, and “the valuation of the stock must temporarily fall when the stock goes” ex-dividend.
Along those lines, the stock’s price gets marked down on the ex-date, Willens says. For example, a stock priced at $50 would be marked down to $49.75 to reflect the impending quarterly dividend payment of 25 cents a share. Of course, the stockholder gets that 25 cents in hand.
However, many other factors influence a stock’s price at any moment, including how its fundamentals are perceived by the market. But a stock’s ex-date is something that dividend investors should at least be aware of.
Write to Lawrence C. Strauss at [email protected]