To receive a dividend from a company you’re invested in you need to hold the shares by a specified date.
So, when a company’s shares trade without the entitlement to their latest dividend the share price often drops by an amount roughly equal to the value of any payout.
Since the FTSE 100 is weighted according to market value, ex-dividend-related share price drops lower the headline index level. A move which is completely separate from underlying market sentiment or businesses’ financial performance.
It is therefore useful to keep in mind that on days when there is a slew of ex-dividends, looking at the FTSE 100 to relative to European peer indices is not an ‘apples-for-apples’ comparison.
A good example of this effect in action was August 13, when a wave of index heavyweights such as HSBC, NatWest, BP, Shell and GSK went ex-dividend, taking a combined 34 points off the FTSE 100 index.
When do I lose access to the dividend?
Buying shares on or after the ex-dividend date means investors are not entitled to the dividend. Typically, cash hits bank accounts around a month to six weeks after the ex-dividend date.
This means there is a short gap between the share price going ex-dividend and the first opportunity for investors to use the cash to buy more shares.
Reinvesting dividends is an important part of investing, from a pure income aspect and total return (share price gain plus dividend) perspective. Studies have shown that dividends represent more than half of shareholder total returns over the long-term.
The ‘snowball’ effect of reinvesting dividends
Reinvesting dividends takes your money and puts it to work.
When you buy more shares, you own a larger slice of the company than you did before. The next time the company hands out dividends, your payout is automatically bigger because you own more shares.
Think of it like rolling a tiny snowball down a snowy hill. At the very top, it picks up just a little bit of snow with every roll. But as it gets bigger, it picks up way more snow with every single turn.
Why do share prices fall on ex-dividend days?
A company’s share price reflects the total value of a business, including the cash it holds. When cash is distributed to shareholders as dividends, the underlying value of the business drops.
While this describes the mechanics, there are other factors at play which can influence the share price on the ex-dividend day. This means the share can fall more than the value of the dividend or even go up in some cases.
What role do dividends play in investing?
It’s important to remember that while dividends are not guaranteed, companies pride themselves on rewarding shareholders with consistent payouts.
This means companies are often loath to reduce or scrap dividends for fear of sending a negative message to current and prospective shareholders.
Some investors believe dividends play an important role in holding company managements to account. Here is the view of Guinness Global Investors.
“If a company has a long history of paying a dividend and the intention to do so in the future, it is highly likely that management will begin each new year by first deciding the dividend payout and then thinking about how best to use the rest of the cash that the business generates”.
When can companies legally pay dividends?
It is worth noting that companies can only pay dividends from accumulated earnings retained in the business, called ‘distributable profits’.
For example, if retained profits are £1 million and a company makes a loss of £1 million in the current year, it cannot legally pay a dividend, even if it has sufficient cash reserves in the bank.
This suggests companies which pay dividends have a history of profitability and are financially sound relative to companies which do not pay dividends.
Generally, dividends are paid from cash, but they can also be paid out of borrowings. Investors may take a dim view of companies which borrow money to pay dividends or engage in share buybacks.
Dividend hikes and initiations often boost the share price
Companies announcing dividend increases are generally rewarded with rising share prices as investors price the prospects of higher returns.
A recent example is NatWest which hiked its dividend by 26% to 12p per share after reporting better than expected second-quarter earnings (31 July) and raising profit guidance.
The company said it would consider share buybacks six months earlier than previously planned. The shares topped the FTSE leaderboard after rising by around 4%.
Rolls Royce reintroduced its dividend at 6p per share in August 2024 marking its first payout since the pandemic and launched a £1 billion share buyback after announcing a 55% increase in operating profits.
The shares went up as much as 15% on the day of the announcement, topping the FTSE 100 index.
Dividend timeline and sequence
Dividend declaration
The board announces the upcoming dividend alongside their earnings report. The board has authority to declare and pay half year and quarterly dividends.
Final dividends require formal shareholder approval, which usually happens at the annual general meeting, often one or two months after the results.
The ex-dividend date
When the stock trades without the right to the dividend. Investors need to own shares before this date to receive the dividend.
The record date
Usually, the day after the ex-dividend date, when the company checks its register to see who is entitled to the dividend.
Payment date
Cash hits shareholders bank accounts, typically four to six weeks after the record date.
Martin Gamble: Shares and Markets Writer
Martin Gamble is Shares and Markets writer at AJ Bell. He was previously the Education Editor of Shares Magazine. He has been with the business since 2019.
Martin graduated from the University of Kent in...
