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My question should be more like: why dividends are inseparable from the appreciation of a stock's price?

The common explanation is something like:

Stock A pays a $10 (10%) dividend and a share is worth $100. Stock B pays no dividend and is also worth $100/share. If they both grow by 10% at the end of the year, you would have the same return on the both of them. This is because A's prices goes up to $110 and after paying a $10 dividend, A's share price goes down to $100. B's price grows to $110. 100+10=110

Makes sense. But not to me. I don't know why but I can't wrap my head around why the dividend takes money away from the share price. I thought the share price was the price for the piece of the company, and not the money is pays out. Is that not true?

To me, I see a dividend as the same thing as income from renting out a property. If you own a $100k house (assume no mortgage) and you rent it out for $1k/month, your yearly income from the house is $12k (12%). If the price of the house goes up 10%, then you still have the $12k but also $110k house so your total net worth is $122k. But if you (for the sake of argument) just owned the house so that it appreciates in value and did not rent it out, you would be $12k short at a 10% growth. This is because rental income is separate from the value of the house, obviously.

Why are dividends not the same? Why do dividends take money out of share price and not considered income from the company the same way rent is income from property?

As an aside, I understand that stocks that pay dividends are not automatically better than stocks that don't. That isn't my claim. Dividends are irrelevant in determining whether a stock is a solid investment (that is not to say they are irrelevant to your returns, see this calculator).

MrMineHeads
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    Are you saying that "government taxes are irrational" ... ? The only answer can be "that's life". – Fattie Jul 21 '20 at 00:46
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    If you bought this house 50-50 with a partner, on the expectation that you would always give the partner $6000 per year (whether rented or vacant), that would be the equivalent of the dividend in your example. – user662852 Jul 21 '20 at 04:56
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    Dividends come from the company itself. It's like if you went and took a tree from your house each month. It doesn't matter whether you leave the tree there or take it away, either way you have the value of the tree plus the value of the rest of the house. – user253751 Jul 21 '20 at 10:20
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    This (much repeated) premise about dividends is flawed. What it misses is that in both theory and empirically a stocks price rises the amount of the dividend and then drops that amount. The only difference between theory and the reality is a great mystery of finance: the aggregate drop in price is less than the rise. – JimmyJames Jul 21 '20 at 14:57
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    @JimmyJames: Is it all that much of a mystery? If the company just paid a dividend, people will reasonably expect that it will keep doing so in the future, thus people who want a dividend stream will be more likely to want to buy the stock, or hold it if they already own it. – jamesqf Jul 21 '20 at 15:06
  • @jamesqf It's a mystery based on the idea that markets are efficient. Given knowledge that this gap exists, arbitrage should quickly eliminate it. It could simply be that effective arbitration strategies are limited for practical reasons. Here's an article about attempting to take advantage of this. It's a little technical but touches on the basics: The Run-Up Before Ex-Dividend Date – JimmyJames Jul 21 '20 at 15:25
  • The basic idea here is called "Dividend Irrelevance Theory" In that link there's an explanation of why your hunch is on the right track: "The dividend irrelevance theory holds that the markets perform efficiently so that any dividend payout will lead to a decline in the stock price by the amount of the dividend." ... "However, studies show that stocks that pay dividends, like many established companies called blue-chip stocks, often increase in price by the amount of the dividend as the book closure date approaches" – JimmyJames Jul 21 '20 at 15:34
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    "not considered income from the company the same way rent is income from property?" Where are you located? In the US, dividends are income for tax purposes. There's a tax break on "qualified dividends" that allows them to be taxed at the capital gains rate. But dividends are definitely income. – JimmyJames Jul 21 '20 at 18:22
  • A brief look at a German (strong tenant laws) real estate sight reveals it's much cheaper to buy an apartment that is rented out than one that is available. You may not be able to do much anything with the former for decades if you're unlucky. – gerrit Jul 22 '20 at 07:34
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    @JimmyJames: Perfectly efficient markets are like spherical cows, or doing your physics problems without taking friction into account. – jamesqf Jul 22 '20 at 15:31
  • @jamesqf I don't disagree but despite that, it's a bit puzzling that there's this known market inefficiency that continues to exist even though it's well known. And why I say it's a mystery, I mean to the researchers and academics who study such things for a living. If you are curious I can probably dig up a paper about this but don't ask me to explain it. – JimmyJames Jul 22 '20 at 15:35
  • @JimmyJames: Try to make free money from this strategy (i.e. buy before the run up, sell after the dividend) and see how it goes over the long run. – Nemo Jul 23 '20 at 19:01
  • @Nemo No you try it. – JimmyJames Jul 24 '20 at 20:11

9 Answers9

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I will give a counterpoint to Bob Baerker's answer.

When your tenant pays you your rent, it does not decrease the value of your house.

It doesn't decrease the value of the house as a physical asset, but it does decrease the value of the house as a financial asset. When you have a tenant, your house is encumbered by a rental agreement (either lease or month-to-month).

Let's say a buyer is required to assume the rental agreement (keep the tenant on the same terms until they can otherwise be renegotiated). Suppose the tenant pays $1,000 rent for August on August 1.

Just before the tenant pays, let's say the buyer is willing to pay $X for the house. That deal includes the buyer receiving the tenant's August rent payment (because the rental agreement has been assigned to the buyer) and continuing to grant the tenant use of the house for the month of August.

On the other hand, if you sell just after the tenant pays you the rent, then the buyer has the same obligation to grant the tenant use of the house for the month of August, but the buyer does not receive that $1,000. It follows that the buyer is willing to pay $(X - 1,000) for the house.

So, a house and a stock are more similar than they may seem. The economic value of a company includes not only its physical assets but also its claims (loans and deposits, accounts payable and receivable). Likewise, the economic value of a house includes claims like rental agreements, liens, etc.

Whenever there is a contractual discrete cash flow whose recipient is determined by who owns property on a particular date, the market value of that property will drop immediately after that date as a new owner will no longer be entitled to that payment.

The value will exhibit a characteristic sawtooth pattern versus time. Even if the physical attributes are stable, economic value builds up gradually as claims (hopefully) accumulate from profitable use of assets, then jumps down when cash is extracted. In between rent payments, the house value has an extra increasing trend because the tenant is using up the month they've paid for, and the owner's remaining obligation to the tenant is declining.

It would be difficult to demonstrate this empirically with real estate since the property value is not precisely quoted daily and value of one month's rent is likely lost in the noise of illiquidity, but the principle is valid.

nanoman
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  • I see, so instead of looking at it as a house and rent, I should instead look at it as a business who's cashflow is determined by rent. That makes more sense. Does that mean that for Stock A, if we assume all else equal (i.e. the Stock does not get more valuable nor does the market go on a bull run or anything like that), the 10% growth over the year was due to the dividend it is going to pay out and that after it pays it out (or reaches ex-dividend date), it drops back to its original valuation? Does that mean that the valuation of the company never changed? – MrMineHeads Jul 21 '20 at 03:08
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    @MrMineHeads Correct, company A is profitable but does not invest in growing its operations. It just collects profits in its bank account and periodically distributes them to shareholders. The variations in stock price are entirely due to the timing of the dividend. However, stock A has genuinely provided a 10% return. – nanoman Jul 21 '20 at 03:47
  • Does that mean that stock prices usually go down after dividends have been paid, making it a potentially good time to buy them cheap? – Lasse Meyer Jul 21 '20 at 11:15
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    @LasseMeyer Yes, stock prices usually go down after dividends have been paid (technically, after the date entitling shareholders to the dividend -- it may actually be paid days or weeks later). But the point is that the benefit of buying the stock "cheap" is counterbalanced by not receiving the dividend. Or put another way, you're not actually buying the company at a cheaper valuation, because you're buying a "poorer" company with less cash in its bank account (by the amount of the dividend it just paid out). – nanoman Jul 21 '20 at 11:27
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    @Lasse Meyer - Stock price always goes down by the amount of the dividend because stock exchanges reduce share price by that amount on the ex-div date. This isn't always apparent the next day because if there's buying and share price rises, it can mask the reduction. nanoman makes an important point. In terms of valuation, after the ex-dividend reduction, the stock hasn't gone on sale. It's a "poorer" company due to the pending dividend pay out. However, many people do indeed buy a stock post dividend because it appears cheaper. – Bob Baerker Jul 21 '20 at 13:44
  • After thinking about this a bit, I think that this answer blurs the lines between the value of the assets and the yield of the assets. – Bob Baerker Jul 21 '20 at 19:51
  • @nanoman wait a moment, do I receive dividends that are paid yearly, even if I bought the shares right previous day before payout? I would have thought I would receive amount based on the length of period I own shares since last payout, no? – Gnudiff Jul 21 '20 at 20:55
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    @Gnudiff You receive the full dividend if you own the stock as of the night before ex-dividend. You could own it for as little as 8 hours if you buy after-hours and sell premarket the next morning. – nanoman Jul 21 '20 at 21:56
  • The analogy is even closer than you imply in the last paragraph because rents, taxes, HOA fees, etc. are prorated daily in the closing statement. So even though the price of a property doesn’t change, the actual funds exchanged in the sale do follow the sawtooth pattern. – prl Jul 23 '20 at 00:02
  • @BobBaerker "stock exchanges reduce share price by that amount on the ex-div date" - this seems wrong to me. Stock prices are determined by the bid/ask price people are willing to buy/sell the stock for, not the exchange. There is generally a shift in price roughly equal to the dividend on the ex-dividend date due to cash assets dropping (the company is distributing cash on its balance sheet), but it's market driven, not an explicit operation by a 3rd party. – Travis Jul 24 '20 at 05:26
  • @Travis Yeah, Bob Baerker and I have been debating that for a while. Neither of us has come close to convincing the other. – nanoman Jul 24 '20 at 07:39
  • @Travis - You and nanoman are entitled to misbelieve whatever you want. However, if you look at the numbers rather than just opine what you think should be happening, you'll find out that it is actually happening right there in front of you with every single stock that goes ex-dividend. All you have to do is look. The truth is out there, right there in front of you. And no, it is not "roughly equal to the dividend on the ex-dividend date due to cash assets dropping" and no, it is not "market driven", aka the auction. – Bob Baerker Jul 24 '20 at 10:36
  • @BobBaerker Trying again to clarify the core disagreement: The evidence you've presented is that the quoted previous close (QPC) is adjusted for the dividend. True. The disconnect is, I don't think QPC has any effect on the price the stock trades at on ex-div day (or any other day). In another comment here, you propose that without this adjustment, one could "just buy near 4 PM, sell in the morning" -- i.e., you're saying an ex-div trade price would be (at least on average) equal to the unadjusted previous close. ... – nanoman Jul 24 '20 at 13:06
  • @BobBaerker ... I hope I have your claim right -- you're saying actual ex-div trades would be priced differently if the exchange didn't adjust QPC. And I disagree because traders (including market makers) will put in whatever bids and asks they want to put in that morning, and all trade prices are determined by auction using those bids and asks. Traders decide for themselves what price they're willing to trade at, regardless of whether QPC is adjusted; they don't slavishly use QPC as their baseline. There is no sense in which an exchange requires trading to "start" from QPC. – nanoman Jul 24 '20 at 13:07
  • @nanoman - It's not that complicated. The stock exchanges reduce share price by the amount of the dividend on the ex-dividend date. That is clearly demonstrated by looking at the close on the two days (ex-div eve and ex-div date). That means that in your brokerage account, you incur a capital loss equal to the amount of the dividend. This happens before trading resumes on the ex-div date. In the morning, traders put in whatever bids and asks they want to put in. That is a subsequent event and has nothing to do with ex-div share price reduction. You are conflating the two events. – Bob Baerker Jul 24 '20 at 13:22
  • @BobBaerker Great! So do you agree that the reason for the ex-div drop in actual trade prices -- the reason you don't get free money if you "just buy near 4 PM, sell in the morning" -- is not because the exchange reduces the quoted close? I.e., actual trade prices (which are determined by bids and asks) would drop the same regardless? Or do you think those bids and asks are in some way "mechanically influenced" by the quoted close? – nanoman Jul 24 '20 at 13:35
  • It's rather pointless for you to keep asking variations of the same question in a number of different ways as well as trying to introduce unrelated information which distracts an diverts this into something else. It's a simple statement. Stock exchanges reduce share price by the EXACT amount of the dividend on the ex-dividend date. Either accept it or refute it. Refuting it involves posting actual closing prices on the two consecutive days and accounting for the 'disappearance' of the dividend amount from that differential. – Bob Baerker Jul 24 '20 at 14:18
  • @BobBaerker It looks like you are arguing semantics. The exchange may adjust the reported close price on ex-div day by the dividend amount, but actual money changing hands to buy/sell the shares on that day didn't execute at that price. – Travis Jul 25 '20 at 17:49
  • @Travis - Your initial statement was it's not true that share price is reduced on the ex-div date by the stock exchanges because share price is market driven, not an explicit operation by a 3rd party. Now it's The exchange may adjust the reported close price on ex-div day by the dividend amount but actual money changing hands to buy/sell the shares on that day didn't execute at that price. At least you're evolving but you still have some distance to go. Ex-div share price reduction occurs BEFORE trading resumes at which time money then BEGINS to change hands. Don't conflate the two. – Bob Baerker Jul 25 '20 at 17:59
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    @BobBaerker I'm not talking about trading resuming the next day, I'm talking about actual trades at close on the ex-div day. Also, by price I'm referring to the value at which one can buy or sell the asset (as I believe are most people since that is what has relevant meaning in the context of this question), not what an exchange lists as the price in historical data. – Travis Jul 25 '20 at 18:05
  • @Travis - One more thing. Can you explain to me why FINRA Regulation 5330 exists.? The rule is titled "Adjustment of Orders." It states that when there is a dividend, open orders must be adjusted by an amount equal to the dividend, payment, or distribution on the day that the security is quoted ex-dividend, ex-rights, ex-distribution, or ex-interest, except where a cash dividend or distribution is less than one cent. If this process is market driven, not an explicit operation by a 3rd party then why is there such a FINRA rule requiring such adjustments? – Bob Baerker Jul 25 '20 at 18:06
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    @BobBaerker Because it is an adjustment required for proper accounting. It does not somehow retroactively change the amount someone paid for a financial instrument on that day. FINRA 5330 is related to open orders that span the dividend day. – Travis Jul 25 '20 at 18:07
  • Travis - The problem that I have with your comments is that you keep introducing irrelevant information into the conversation. What you paid for the security has no bearing on ex-dividend share price reduction. What is relevant is the value of your position. Because stock exchanges reduce share price by the EXACT amount of the dividend on the ex-div date, FINRA 5530 mandates that all open orders be adjusted by that amount. As I mentioned before, the truth is out there. All you have to do is look. – Bob Baerker Jul 29 '20 at 01:03
  • @BobBaerker That you can't understand why these comments are relevant just demonstrates how confused you are about this. You have one fact that you repeat over and over again regardless of how obvious it is. – JimmyJames Jul 29 '20 at 12:19
  • @BobBaerker No one needs to guess about why FINRA 5330 exists. You can read it here: "... to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, and, in general, to protect investors and the public interest." In other words it would be to protect the kind of people who don't understand things like the points Travis has made here. – JimmyJames Jul 29 '20 at 13:59
  • DCP closed at $12.65 yesterday (7/29). This morning it went ex-div for 39 cents. At 7:30 AM today (7/30), it has not resumed trading. Current price is $12.26 (unch) which is 39 cents lower than yesterday's close after share price was reduced by the exact amount of the dividend. (2) NNN closed at $36.63 with ex-div today for 52 cents. At 7:30 AM today (7/30), it has not resumed trading. Current price is $36.11 (unch) which is 52 cents lower than yesterday's close after share price was reduced by the exact amount of the dividend. You can deny reality if you want but the numbers tell the truth. – Bob Baerker Jul 30 '20 at 11:30
  • @BobBaerker Yes we all know about that. That's what we are discussing. Try to keep up. – JimmyJames Jul 30 '20 at 17:58
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Just to give an alternative analogy to the other answers:

Think of a company as being like your bank account. If the bank account has $100 and it earns 10% interest per year:

A) If you decide to keep the interest in the account, then at the end of the year the account has $100 + $10 = $110. This is analogous to a company earning profits of $10 and retaining those profits.

B) If you decide to withdraw the interest in the account, then at the end of the year the account has $100 but you have $10 in cash = $110. This is analogous to a company earning profits and paying them out as dividends. The bank account / company is worth $100 instead of $110 because it now no longer has the extra $10.

If you own a $100k house (assume no mortgage) and you rent it out for $1k/month, your yearly income from the house is $12k (12%). If the price of the house goes up 10%, then you still have the $12k but also $110k house so your total net worth is $122k. But if you (for the sake of argument) just owned the house so that it appreciates in value and did not rent it out, you would be $12k short at a 10% growth. This is because rental income is separate from the value of the house, obviously.

This analogy is incorrect. With the company that doesn't pay dividends, it is still earning the profits of $10, just choosing not to pay them out to shareholders. In your example where you don't rent out the house, you are failing to make any profits at all. These are not comparable scenarios. The correct analogy is that you rent out the house for $12k, but instead of receiving that money as income, you re-invest it into the house (e.g. by improving or enlarging it). If we assume that $12k of improvements results in $12k of extra value on the house, your house is now worth $122k as expected. This is what happens with the non-dividend paying company: the $10 that it fails to pay in dividends is retained in the company and increases its value by "improving" it (by increasing it's cash balance).

JBentley
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    This is a very good analogy for the comparison of dividends and rent. It deals in actual value rather than esoteric economic value. +1 – Bob Baerker Jul 21 '20 at 13:59
  • The problem with the bank account analogy is that the book value of a company is not the market valuation. If you can find a where the book value and market valuation are equal, it's probably a failing one. – JimmyJames Jul 29 '20 at 15:03
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    @JimmyJames True, but analogies are aids to understanding rather than accurate definitions. – JBentley Jul 29 '20 at 22:19
  • Unless they are misleading. Then they can inhibit understanding. The book value of a company has a very indirect and subtle relationship with the stock value. The book value of a bank account is its value. It's revenue that is core to the valuation of a company. The amount of cash on hand is a factor but has no direct 1-to-1 association with its value. Therefore the idea that the value of the stock dropped by dividend amount because it has that much less cash is preposterous but that's the implication of your analogy. – JimmyJames Jul 30 '20 at 15:49
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    @JimmyJames Revenue is a part of the value of a company, but there is no denying that cash has value. Ceteris paribus, if company X has $1 more cash than company Y, then it is worth $1 more. Similarly, if a company has $100 in its bank account today, and tomorrow it has $99 because of a dividend payout (i.e. nothing else to show for the $1 spent), then ceteris paribus it is worth $1 less than it was yesterday. There is nothing preposterous about that, it is basic accounting principles. – JBentley Jul 30 '20 at 23:11
  • Absolutely false. Show me some evidence. – JimmyJames Jul 31 '20 at 13:30
  • You are also assuming that the dividends are subtracted from the current balance. Most dividend paying stocks fund those payments from profits i.e. cash flow. If anything, their cash balance will be higher than normal prior to the payment. The idea that the dividend necessarily reduces their book value is wrong. – JimmyJames Jul 31 '20 at 13:33
  • I'd be willing to consider this if you can show some stock price valuation method that includes book value. One of the oldest and most conservative approaches is based on dividends alone. Other measures of company performance penalize companies for sitting on cash because it reduces their return on equity. It would also be important to show how only dividends have this effect on value but all the other ways companies use cash don't. Or explain why a company that hoards cash is more valuable than one that uses it to reward investors or growing the company. – JimmyJames Jul 31 '20 at 17:06
  • @JimmyJames It makes no difference where dividends are "subtracted from". Where do you think "current balance" comes from? Profits from a financial year become part of that balance. This is basic accounting - you can check with your accountant if you require evidence. Note my use of the phrase ceteris paribus (all other factors being equal). If you take two otherwise identical companies, A has cash reserves of $99 and B has cash reserves of $100, then B is worth $1 more than A. If B were to liquidate, its shareholders would receive $1 more than A's shareholders. – JBentley Aug 04 '20 at 08:22
  • As for "all the other ways companies use cash don't" - if a company for example uses $1 of cash to purchase $1 of stock, it's value (ceteris paribus) remains the same: it loses the cash but it gains the stock. Dividends are different because they are an exit of value from the company to the owners of the company. – JBentley Aug 04 '20 at 08:30
  • @JBentley I'm still waiting (years) for an authoritative reference that backs up this 'flat earth' model of dividends. I've provided plenty that show it is not why prices drop after the dividend is issued. The real answer is so much simpler: the price starts rising on dividend announcement because sellers are compensated for the pending payment. It's a feature of stocks as a financial instrument. Paying dividends has an impact on value but that impact is nuanced and depends on the investor. Finance is not accounting. – JimmyJames Aug 04 '20 at 12:50
11

What's the difference between dividends and rent?

When a dividend is paid, cash is removed from the company, decreasing the company's value. For that reason, stock exchanges decrease share price by the exact amount of the dividend on the ex-dividend date.

When your tenant pays you rent, it does not decrease the value of your house.

Per your example, a $10 dividend is paid once a year. If share price was not reduced by the amount of the dividend on the ex-dividend date, everyone would buy your $100 stock at the close the day before the dividend and in the morning, the stock would be $100 before trading opened and you would be due $10 on the Pay Date. Free money!!! Now what's wrong with that picture?

I think that dividends being taxed as income has led to a massive misconception by the public that dividends are income. They're not. They are merely cash flow from the value of your equity positions and in and of itself, a dividend provides zero total return. Only share price appreciation provides total return. Note that this refers to what happens to share price in your brokerage account on the ex-div date not the corporate side.

Another Catch 22 issue is the relevance of dividends to one's return. The powers that be often state the S&P 500 has returned X% over some number of years with Y% coming from dividends. Suppose it was 7% of total return with a 2% dividend. In reality, it all came from share price appreciation. That's because in order for a 2% reduction in share price (dividends) to be total return, share price must recover that 2%.

As previously mentioned, dividends provide zero total return on the ex-div date. When reinvested, they alter the calculation because now you have additional shares compounding the return when share price appreciates. If share price drops (actual drop due to selling, not ex-dividend reduction) then with dividend reinvestment, there will be negative compounding. While it is possible to break these apart by using adjusted share prices, it's a royal headache to do so. An easier way is to just use a DRIP calculator and compare the total return of reinvesting versus not reinvesting. Here's one such calculator. Just understand that all of the gain comes from share price appreciation.

the short answer? A stock and a house are not the same.

Bob Baerker
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  • Paragraph 4 is the bottom line. i.e. if the price were not adjusted, the result would be strange. – JTP - Apologise to Monica Jul 21 '20 at 19:27
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    If one could buy a stock at the close, be entitled to the dividend the next morning (ex-div) and not have share price reduced, there would be no reason to buy other stocks. Just buy near 4 PM, sell in the morning, repeat every day, and laugh all the way to the bank. OK, time for all of the 'free money' dreamers to give up the fantasy :->) – Bob Baerker Jul 21 '20 at 19:44
  • When your tenant pays you your rent, it does not decrease the value of your house. — then why is it much cheaper to buy an apartment that is rented out than one that isn't, at least in countries with tenancy protection? If I buy a home that is unoccupied, I can choose to live there tomorrow or rent it out. If I buy a home that is rented out, I may not be able to get the tenants out in the next 50 years (i.e. until they move out or die, and I'm not sure about the latter). – gerrit Jul 22 '20 at 07:38
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    "Why is it much cheaper to buy an apartment that is rented out than one that isn't, at least in countries with tenancy protection?" With that logic, a stock should cost less because it is "going" to pay a dividend. Unfortunately, it doesn't work that way. As for your inability" to get the tenants out in the next 50 years until they move out or die" that has nothing to do with anything other than the fact that they have a rental contract. Again, irrelevant to the dividend versus rent comparison. – Bob Baerker Jul 22 '20 at 18:04
  • "They're not. They are merely cash flow from the value of your equity positions and in and of itself, a dividend provides zero total return. Only share price appreciation provides total return." Can you provide a reference for this non-standard assertion? – JimmyJames Jul 27 '20 at 18:21
  • All you have to do to see this is to look at your EOD account statement the day before and the morning of the ex-dividend date for a position that you own that is paying a dividend. It's right there in front of you. All you have to do is look. Plan B? CLX goes ex-div tomorrow morning for $1.11. Look up today's closing price and then in the morning before trading resumes, look at the closing price. Compare the two. If you owned the position, your account value would be $111 less per hundred shares with $111 per 100 shares owed to you on the Payable Date which equals zero total return. – Bob Baerker Jul 27 '20 at 18:55
  • Plan C? Read this Vanguard explanation. Plan D? Read this explanation. Plan E? Use a DRIP calculator (a more complex endeavor) that demonstrates that the underlying must recover back to the ex-div share price reductions in order for the dividends to be a profit. If it doesn't, you'll have zero total return. Perhaps after all of this (5 different ways to see this) then you'll have a light bulb moment. – Bob Baerker Jul 27 '20 at 18:55
  • None of that backs up your assertion. Let's start with the basics. Where do you think the cash comes from in a dividend payout? – JimmyJames Jul 28 '20 at 16:17
  • And here's a description: "Impact of Dividends on Share Price Since dividends are irreversible, their payments lead to money going out of the company’s books and accounts of the business forever. Therefore, dividend payments impact share price – it rises on the announcement approximately by the amount of the dividend declared and then declines by a similar amount at the opening session of the ex-dividend date." It doesn't need to 'recover' because the rise is first. Please provide an authoritative reference that contradicts this. – JimmyJames Jul 28 '20 at 16:21
  • Sorry your last link does share your non-orthodox view. It's also the one of the shittiest websites I've seen lately and contains no attribution. – JimmyJames Jul 28 '20 at 16:28
  • @JTP-ApologisetoMonica It's a little concerning that a moderator on this site is subscribing to a 'flat earth' theory about dividends. – JimmyJames Jul 28 '20 at 20:36
  • You object to Bob's para 4? It seemed sort of obvious. – JTP - Apologise to Monica Jul 28 '20 at 21:02
  • @JTP-ApologisetoMonica What I object to is "They are merely cash flow from the value of your equity positions" which is absolutely a new theory of economics that would need significant explanation. If you are referring to the paragraph before, then my apologies. – JimmyJames Jul 28 '20 at 21:29
  • "Suppose that share price....." is the 4th para, that I was expressing agreement with. – JTP - Apologise to Monica Jul 28 '20 at 21:32
  • @Jimmy James -There are a lot of pretty savvy investors who participate here. Almost all of them understand that share price is reduced by the exact amount of the dividend on the ex-dividend date. And then there are a few outliers like you whose do not grasp this. If stock market climate deniers like you were indeed correct, there would be a parade of Stack participants commenting on your behalf, supporting your refutation. Listen carefully: The silence is deafening and so it's just you out there on a limb by yourself. – Bob Baerker Jul 29 '20 at 01:07
  • @Jimmy James - It's clear that you do not grasp this nor do you want to. For that reason, I'm going to leave you to your tunnel vision fundamental analysis which has no bearing on what I have described. In parting, here's a riddle for you. CLX closed yesterday 7/27 at $229.22. It went ex-dividend this morning for $1.11. Today, 7/28 it closed at $228.55, up 44 cents. How is it possible that it was up 44 cents today but yet today's close is 67 cents lower than yesterday's close? How did $1.11 magically disappear from the closing price overnight? And therein lies the answer. – Bob Baerker Jul 29 '20 at 01:14
  • This is my last comment. Every shareholder who owned CLX overnight lost $111 of position value overnight per 100 shares owned. However since ex-div entitles them to the dividend, they will receive $111 per 100 shares on the Payable Date so NO account value was lost due to the dividend. The funny thing is that for every stock that you own that pays a dividend, this is happening to you. The problem is that you are oblivious to it. Perhaps one day the light bulb will go on. Tata. – Bob Baerker Jul 29 '20 at 01:15
  • @BobBaerker Everyone already knows that the price drops at the ex-dividend date. You just don't seem to be able to get your head around the fact that the price rises the same amount after the announcement prior to that. It requires keeping at least two facts in your mind at the same time. You really don't know where the cash for the dividends comes from, do you? – JimmyJames Jul 29 '20 at 12:14
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The house example can be appropriately modified, without concerning the actual sale of the property (which is a good example, also), to match the stock market.

The rent the tenant pays is the source of income for the house, not for the owner of the house, in this example. The house is the company, remember! Just like a company that sells widgets would sell $10k worth of widgets, and that would cause its value to appreciate by $10k, the house sells tenancy, and so appreciates in value by the rent paid for it. That's separate from appreciating in value due to the market, or due to capital improvements, or any other reason the value might increase: it's simply an increase from income. So the house is worth $100k, plus the accumulation of rents it has taken in but not yet paid out.

In your example, you immediately take that "dividend" of rent from the house - which is not directly possible with a public company, but only because of SEC regulations. But you could just as easily have taken that money and built an addition, right? Just like any public (or private) company, which has income, can make a similar choice:

  • Dividend that income back to the owner(s) - value of company reduces by dividend $
  • Make capital improvements - value of company changes based on perceived value of those improvements (could go up, down, or stay neutral)
  • Keep cash in reserve - value of company stays neutral

If you did keep the house in a company (as some people do!), then you would have exactly the same math to do - that company's value would decrease each time you took a payout (dividend).

Joe
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Because a stock and a house are inherently different things. To compare them more meaningfully, consider them in a more equivalent way. The stock is ownership of (part of) a business. That business includes employees (who provide labor) and assets, and generates some amount of profit (or loss). The house is just a house; you need to put it your own time and effort (and money) to maintain it, find tenants, collect rent, pay taxes, etc. You could consider that whole enterprise (the house plus all your associated work) as a company.

If we assume stock A and stock B are both companies whose business is "being a landlord", and they each own one (approximately identical) house, then (a very simplified, not-exactly-realistic, version of) the scenario in your question looks like this:

  • Company A owns a $100,000 house (and nothing else) and has no debts/expenses. There are 100 shares of the company, so each share is worth $1000. The tenants pay $1,000 in rent, which is immediately paid to each shareholder as a $10 dividend. The company still owns exactly $100,000 in assets (the house; ignoring depreciation, maintenance, etc.), so each of the 100 shares is still worth $1000.
  • Company B owns a $100,000 house (and nothing else) and has no debts/expenses. There are 100 shares of the company, so each share is worth $1000. The tenants pay $1,000 in rent, which the company keeps. The company now owns $101,000 in assets ($100,000 house, $1,000 cash), so each of the 100 shares is now worth $1010.

If I buy a share of company A, I get a piece of ownership of a business that owns a $100,000 house. If I buy a share of company B, I get a piece of ownership of a business that owns a $100,000 house and $1,000 in cash. That additional cash may be paid out as a dividend in the future (bringing Company B in line with Company A), or it may be used for further investment (e.g. buying a second house, improving the first house to increase rent, etc.).

yoozer8
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A company's share price is essentially a combination of two things:

  1. The value of all the company's assets (its book value), and
  2. investors' estimate of the future prospects of the company (is this a "good investment?").

The assets include the cash in the company's bank accounts. When they pay out a dividend, they have less cash in the bank, so their book value drops. If nothing else has changed, it simply makes mathematical sense to decrease the share price accordingly.

In reality, things aren't quite that simple. For some investors, the prospect of receiving regular dividends is what makes a company more valuable than some other similar company. It's similar to the reason why some people buy bonds rather than stocks -- even though the overall returns may be less, the security of receiving payments on a regular basis is valuable in itself.

But at the moment that the company pays out its dividend, these effects can be ignored. It's still the case that the company's assets have been reduced, so no matter what you think about whether it's a good investment, it can't really be as valuable as it was when it had that cash in the bank.

Barmar
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  • If you take Clorox (CLX) the book value per share is around $5.5 and the stock price is around $230. So based on your claim here, 97% or more of the value is based on investors future prospects of the company. This is Clorox, not some startup. Does that really make sense to you? If there was a company that just held dollars and paid people (with those same dollars) to manage them (until they were all gone), would you value it at the book value? – JimmyJames Jul 29 '20 at 19:14
  • What else could that other 97% be based on? "future prospects" also includes things like safety -- how likely is the company to still be around and successful in the future? So a blue chip company like Clorox is worth the high price because you're not likely to lose your money (but don't forget about General Electric). This is the difference between value and growth investments. Stock pricing is not a simple thing. – Barmar Jul 29 '20 at 21:12
  • I would think revenues would be a big factor. That's kind of the point of a business, is it not? Book value has almost nothing to do with profits. Probably the most common measure for a company is it's PE ratio. If you look at CLX stats, the dividend payout is a tiny fraction of it's monthly revenues. Any impact on their book value should be pretty fleeting. It's kind of like how when I make my monthly mortgage payment, my net worth doesn't go down. I'm paying it from my income, not my savings. – JimmyJames Jul 29 '20 at 21:27
  • @JimmyJames Expected revenues are part of what goes into estimating future prospects. – Barmar Jul 29 '20 at 21:28
  • "future prospects" is everything that goes into evaluating the company that isn't just "stuff". – Barmar Jul 29 '20 at 21:30
  • But a company can have poor outlook and still have value. Often, companies that have reached their limit of growth are the ones that are paying dividends because reinvesting would be a waste. A declining company with a revenue stream (e.g. IBM) can still direct their current revenue stream towards rewarding investors directly instead of squandering it on things it cannot achieve. – JimmyJames Jul 29 '20 at 21:33
  • In any event, in order to believe that the reason the price drops the amount of the dividend is because of book value means you are ignoring all of this:particularly that the book value is typically no where near being equal to the market value. If you don't agree, can you explain how something that clearly is insignificant to the valuation is somehow totally significant that valuation when it's used to pay a dividend. – JimmyJames Jul 29 '20 at 21:36
  • As I said, stock pricing is complex. There are many components, and feedback effects. – Barmar Jul 29 '20 at 21:38
  • But the price drop after dividend is quite simple and precise. How do you square that circle? – JimmyJames Jul 29 '20 at 21:54
  • Because it's a simple value that operates independently of all the other aspects of the company operations. – Barmar Jul 29 '20 at 22:09
  • It's because it has nothing to do with book value. – JimmyJames Jul 30 '20 at 15:38
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I have once seen the question from another angle that should explain to you why the value decreases and why it has to decrease:

Imagine you've got stock that pays dividend. If dividend is paid once a year, why to buy such stock and keep in it your money for entire year if you could by 1 day before paying out dividend (actually the day it is decided you will get dividend if you hold the stock) and then the next day collect the dividend and sell the stock immediately just to repeat the process next year.

And the answer is - immediately after paying out dividend the stock price drops by approximately the dividend amount just to limit people from earning the money that way.

Going back to renting house example you have used - imagine you rent a house, you've got permanent tenant in it paying the rent and the rent is paid once a year. You can then sell the house along with tenant but it is clear that the value of such transaction will vary over they year. Once it is close to the rent being paid it is higher (approximately by the amount of the rent you will immediately get back) and will be lower when the rent will be paid in longer period. If you think this way it is very logical conclusion the price of such asset (not only being asset but a rented asset) must drop immediately after rent is paid.

mr100
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Say that you own an LLC that owns a house worth $100k and rents it out for $12k/year like your example. That $12k is revenue for your LLC. Your LLC will have to pay property taxes and for other things like accounting, so let's say you have $7500 cash in the account at the end of the year. And let's say the housing market jumps so the house is now worth $110k.

You could pay yourself the $7500 which would be like a dividend. Now the LLC's only assets are the $110k house.

Another option would be to keep the money in the LLC. The LLC now has has assets of $117,500. You may be saving up to buy a second rental property. Or you could use that $7,500 on improvements to the property (landscaping, electric water heater, whatever) which would increase the value beyond the $110k.

That's what a company that doesn't pay dividends is like. You don't get that regular income, but the expectation is that the money will be used to make the company more valuable and increase the stock price.

Jason Goemaat
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I understand that your title and your question differ wildly. And other answers tackle that beautifully. However, because others are likely to come here based on the title, which currently is "Why are dividends different from property income like rent" and I would hate to see them disappear frustrated when I have the answer to that question as stated.

Dividends are taken from the available cash of a business. This cash has already been taxed by a corporate tax, so it is not taxed at the same rate as regular income. As a more personal finance related example, keeping in mind this varies from jurisdiction, so talk to your accountant to find the breakeven point, in my area if you're self employed and making 250k a year (500k if married) then you want to pay yourself a salary up to about that 250k and after that declare dividends. At that point, the personal tax becomes high enough that you are better off eating the corporate tax on the "profit" of the business and then eating again the tax on dividend - the two of them add up to less than the top tax rate.

corsiKa
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  • I am not the downvoter, but I have a correction: dividends come out of profits or retained profits, not cash. It's an important distinction. A loss making company can have available cash for example, but would not pay dividends from it. – JBentley Jul 23 '20 at 12:11
  • @JBentley It's an important distinction, but not a correct one. Companies can take a loss and still declare a dividend from available cash flow. Many choose to do so in order to not spook investors if they have a bad quarter, for instance. However, what might be considered important is that the cash paid as a dividend is taxed - you cannot write it off as a loss if you pay it out as a dividend. See https://money.stackexchange.com/a/52120/3093 for a bit more background on that. – corsiKa Jul 23 '20 at 23:54
  • That is why I said you can pay dividends from profits or retained profits. The latter covers the situation where a company is loss making but has previously retained profits available and spare cash. It is unlawful in most jurisdictions as far as I know (and certainly in the UK) for a company to pay dividends where there are no available retained profits (i.e. out of capital). See e.g. here or here. – JBentley Jul 24 '20 at 20:03
  • And if you think about it, the reasons for it being unlawful are fairly obvious: it would be a fraud against the creditors of the company, because they are first in line before shareholders in the event that the company is liquidated. If the company has paid dividends without retained profits, then they must have been paid either by increasing the liabilities e.g. via a loan (thus effectively cheating some portion of the creditors) or by out of capital (cheating the creditors because that capital is what the shareholders agreed their liability would be limited to). – JBentley Jul 24 '20 at 20:08
  • @JBentley Your "fairly obvious" line of reasoning doesn't really make sense. Creditors know that shareholders are important to a corporation. As long as you're making your payments to the creditors, they really don't care. – corsiKa Jul 25 '20 at 20:37
  • I was referring to creditors' legal rights, as opposed to they care about. When a company goes bust, in simple terms the creditors are first in line over shareholders for whatever assets remain. They have the expectation of this method of recovery whenever they agree to lend money to the company. Paying dividends out of losses or shareholder funds would remove or reduce this method of recovery. Hence it is unlawful in most jurisdictions. But in any case, I don't agree that creditors only care about you making payments. They also care about the credit risk of recovering the capital. – JBentley Jul 26 '20 at 12:31