Certified financial planner Wes Moss provides personal finance advice and accessible investment strategies. His guest post appears here weekly.
Here’s a common question I get in my role as a financial advisor who advocates income investing, which includes the purchase of dividend-paying stocks: Why do the prices of such shares seem to fall by the exact amount of the dividend they just paid me?
As one client put it: “I had a $100 stock and it paid me $1 this quarter. But on the day I received my $1 in cash, the share price went down to $99. Isn’t that company just giving me my own money back?”
No; the company actually is passing on profits to you. And you are gaining something.
Here’s how it works: On the day the dividend is issued, an investor receives his or her $1, which represents the person’s share of the company’s earnings for that quarter. The company itself has likely grown in value leading up to the dividend, and its share price should move higher because the enterprise value has grown — and move even higher in anticipation the stock will pay a dividend.
So when you receive a dividend, your share price should reflect the cash you are going to receive before you receive it, and then adjust downward temporarily.
Example: Imagine you gave me $100 to run my fantasy business, Wes Moss Industries. By the end of the year I generate profits of $10. My enterprise value is now at $110. My share price should be $110. But right before the end of the year, I pay you $3 dollars out of my $10 profit. Now my enterprise value is only $107. But you made $7 in appreciation and $3 in income, so you have still earned 10 percent total, even though the stock price on the Yahoo or Google Finance stock trackers will show Wes Moss Industries is up only 7 percent.
So even though you may see your stock, exchange-traded fund (ETF) or mutual funds adjust down on the day it pays you an income, remember it has performed well enough to pay you that dividend. If you are pleased with that outcome, consider reinvesting that $3 dividend right back into the company by buying more shares with your newfound cash.
If you want to get going with dividends — or want to get somebody started, in the form of a gift — here are just two of the many places to start:
1. OneShare.com: This online store sells framed, colorized stock certificates. Just pick your company and give the gift in style.
No, it won’t get to your recipient in time for Christmas at this point, but you can print a neat-looking gift announcement until the actual certificate arrives.
2. ShareBuilder.com: This online brokerage offers trades as low $9.95 and automatic reinvestment of dividends for about $4.
– Wes Moss, for AJC Atlanta Bargain Hunter blog