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Dividend Basics: The Mechanics of Dividend Payments

Josh Peters, CFA

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser.

Many beginning dividend investors wonder when they'll actually get their dividend payments. I am here with Josh Peters, the editor of Morningstar DividendInvestor and also our director of equity income strategy. He is going to demystify the process and give us more insight into the dividend-payout cycle.

Josh, thanks for joining me today.

Josh Peters: Good to be here, Jeremy.

Glaser: Let's start with the basics. Can you talk about exactly how a dividend goes from being announced by a company, or approved by the board of directors, to showing up as a check in your brokerage statement?

Peters: Jeremy, there are four key dates that people need to be aware of in a dividend-payment cycle. I'm going use the dividend that was just declared by one of my favorite companies, Spectra Energy Corporation, which we hold in our Dividend Builder model portfolio--the ticker symbol is SE.

On Jan. 6, they actually announced the dividend. That is the announcement date or the declaration date. The board of directors has gotten together and formally approved the dividend payment to shareholders, and that's what starts the rest of the process going.

The second key date that you're going to find in every dividend press release is the record date, and this is when the books have been closed and only the legal owners of the shares as of this date are entitled to receive that dividend. In the case of Spectra Energy's next dividend payment, that's Feb. 14. And then on the payment date, which is very simply titled, March 10 in this case, that's when the dividend is actually deposited into people's brokerage accounts or perhaps mailed or direct-deposited to them directly.

Funny thing is, in most dividend press releases, the most important date of this cycle is actually not shown, and that's called the ex-dividend date. The ex-dividend date is two business days before the record date, two market trading days before the record date. In this case that's Feb. 12. This is the day that marks the division from a practical standpoint between being able to receive the dividend and not.

Stock trades in the United States takes three days to settle, so if you make a trade today it's going to be three business days before your broker has actually obtained the shares from whoever sold them and move your cash over to whoever sold those shares to you. That necessitates a little extra time in the process. But the key point here is that on Feb. 12, if you buy shares on that date, you are no longer eligible to receive that dividend. If you bought shares on Feb. 11, even if you were the very last trade of the day, then you are eligible to receive that dividend that's going to be paid on March 10.

Glaser: Let's dive into that ex-dividend date a little bit more. If the price is going to fall by the amount of the dividend, doesn't that negate the value of the dividend? For new investors, should they be thinking of buying before or after that ex-dividend date?

Peters: A lot of people who come to dividends and are new at it, they think that they can just buy the stock before the ex-dividend date, sell it on or right after the ex-dividend date, and I get the dividend and its a freebie.

Well, there is no free lunch, and over such a short time period, the dividend is really a wash, because there is an automatic adjustment that takes place to the market price of the stock--it will drop by the exact amount of the dividend when the trading opens in the shares on that ex-dividend date.

So, if you buy the stock right before; in this case, say on Feb. 11, the next day the stock has automatically adjusted downward and then the stock will go up or down based on market forces from there. But you haven't gotten yourself a freebie. In fact, what you've done is turned a little bit of your capital into something that looks like income. And if it's taxable, you would actually do better to wait until that ex-dividend date, buy the shares that day, pay a little bit lower price and then you start receiving dividends with the next payment.

Dividends are really about long-term periods. The way I look at it is this: In order for me to benefit from the dividend, I should've owned the shares at least as long as it took the company to earn the money necessary to pay the dividend. So, even though there are strategies out there, sometimes people talk about "dividend capture," like there is some sort of magic formula here to just print money by buying stocks to get the dividend payments and then selling right away. It doesn't work, and there's really no reason to try it. You do have to have that much longer timeframe in mind.

Glaser: For those long-term investors who may be holding a dividend stock for decades, should they care about these press releases, care about this dividend payment cycle, or is it just more of an FYI of when they are going to see it in their statement?

Peters: Well, one of the other things you're going to find in any dividend press release is how much you are actually going to get, which is certainly a useful piece of information. For Spectra Energy's first-quarter dividend, they announced a rate of $0.335 a share. That's notable for a couple of factors.

First, if you multiply that by four, that gives you the annualized dividend rate. If you own the share of stock for a whole year, and the dividend rate continues at this level, which is usually the case, then you would expect to receive a $1.34 a share in dividends. That in turn allows you to calculate the dividend yield. You divide that $1.34 by the stock's current price. Recently, the stock has been trading around $35. That gives you an annualized dividend yield of 3.8%, which you can then compare to other dividend-paying stocks or perhaps to fixed-income alternatives. You never want to confuse the dividend yield with an interest rate on a bond that's a contractual guarantee, but it does give you a way of assessing the income return potential from dividend-paying stocks.

And then my favorite part about this particular announcement is that it was an increase. The previous quarter they paid $0.305; now it's $0.335. The dividend rate has gone up by almost 10%.

Those are all very important pieces of information that help you determine what kind of income you can expect from the stock. And when you look at the series of many dividend payments over many years, see the good growth that a company like Spectra has provided and should continue to provide, put that in the context of a yield that is, in this case, close to 4%--this is how you put together a good investment case for, in this case, what we think is a pretty low-risk business.

Glaser: Josh, thanks for your update on dividend basics today.

Peters: Thank you too, Jeremy.

Glaser: For Morningstar, I'm Jeremy Glaser.

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