Today, on the subject of dividend strategies, we're going to look at the idea of "arbitraging the dividend calendar". As we've discussed elsewhere, a stock is typically valued on the basis of its future cashflows which, in turn, gives rise to an expected future dividend stream (hopefully!).
As a result, when a stock pays out a dividend, one would expect the price of the stock to fall by the amount equal to the dividend since that amount of value has been extracted and is no longer available to new purchasers of the stocks.
However, in reality, practice seems to diverge from this theory (i.e. the stock usually falls by less than this amount). This has given rise to a possible (somewhat disputed) short-term trading strategy know as "dividend stripping" or "dividend capture" discussed below.
Dividend Mechanics
Before getting into that, it's worth clarifying some basics about exactly how dividend payments work. A company's Board decides how much each dividend payment will be. Each company will typically have its own dividend policy in which they outline what percentage of the profits will be distributed, but companies are under no obligation to pay a dividend of any set level. Usually, this percentage ranges between 15-50% depending on the strength/maturity of the company and the volatility of its cashflows. This proportion (DPS/EPS) is known as the Payout Ratio in the US - the more commonly discussed measure in the UK is the inverse, called the Dividend Cover (EPS/DPS).
Once the dividend has been declared, it will be paid to every shareholder. In the UK dividends are normally paid semi-annually, after a company's interim and full-year results (e.g. split one-third at the interim stage and two-thirds at the year-end). However, some larger companies pay out dividends each quarter. The process of paying a dividend has several stages....
1. Announcement/Declaration Date: When a company publishes its results, normally between one and three months after the end of each half-year period, it will declare how much and when its next dividend payment will be. At the time of a dividend declaration is made, the company will typically announce three dates alongside the payment. These are the record date, the payment date and the ex-dividend date, although the phrasing used in the announcement may be different, eg. the dividend "...will be paid on [payment date] to shareholders on the register at [record date]".
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